**UNITED STATES SECURITIES ANDEXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**Form 10-Q**

 

**(Mark One)**

| **ý**                                                  | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF   THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                     |
|-------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                                  | ** **                                                                                                                                                                                                                                                                                              |
| **For the quarterly period  ended September 30, 2004** |
| ** **                                                  | ** **                                                                                                                                                                                                                                                                                              |
| **or**                                                      |
| ** **                                                  | ** **                                                                                                                                                                                                                                                                                              |
| **o**                                                       | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF   THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                    |
| ** **                                                  | ** **                                                                                                                                                                                                                                                                                              |
| ** **                                                  | **For the transition period from                         to                       .** |

 

**Commission File Number 000-50405**

 

**Acusphere, Inc.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                     | ** ** | **04-3208947**                      |
|------------------------------------------------------------------|------------|-------------------------------------|
| (State or other jurisdiction of   incorporation or organization) |       | (IRS Employer   Identification No.) |
|                                                             |       |                                |
| **500  Arsenal Street   Watertown, Massachusetts**               | ** ** | **02472**                           |
| (Address of  principal executive offices)                        | ** ** | (Zip Code)                          |

 

Registrant’s Telephone Number, Including Area Code:

**(617)648-8800**

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes  ý   No  o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act).  Yes  o  No ý

 

As of November 9,2004 there were 17,802,288 shares of the registrant’s common stock, $.01 parvalue per share, outstanding.

 

 

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**ACUSPHERE,INC.**

 

**Form10-Q**

**Forthe Quarterly Period Ended September 30, 2004**

 

**CONTENTS**

 
| PART I: FINANCIAL  INFORMATION                                                                                    |   |
|-------------------------------------------------------------------------------------------------------------------|--------|
| Item 1.  Consolidated Financial Statements                                                                        |   |
| Consolidated Balance Sheets  (Unaudited):  December 31, 2003 and September 30, 2004                     |   |
| Consolidated  Statements of Operations (Unaudited):  Three and Nine Months ended September 30, 2003 and 2004 |   |
| Consolidated Statements  of Cash Flows (Unaudited):  Nine Months ended September 30, 2003 and 2004           |   |
| Notes to  Consolidated Financial Statements (Unaudited)                                                           |   |
| Item  2. Management’s Discussion and Analysis of Financial Condition and Results of  Operations              |   |
| Item  3. Quantitative and Qualitative Disclosure about Market Risk                                                |   |
| Item 4. Controls and  Procedures                                                                                  |   |
| PART II: OTHER INFORMATION                                                                                        |   |
| Item 1. Legal Proceedings                                                                                         |   |
| Item  2. Unregistered Sales of Equity Securities and Use of Proceeds                                              |   |
| Item 3.  Defaults Upon Senior Securities                                                                          |   |
| Item  4. Submission of Matters to a Vote of Security Holders                                                      |   |
| Item 5. Other Information                                                                                         |   |
| Item  6. Exhibits                                                                                                 |   |
| Signature                                                                                                         |   |

 

1

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**PART I: FINANCIAL INFORMATION**

**ITEM 1.****  CONSOLIDATEDFINANCIAL STATEMENTS**

 

**ACUSPHERE,INC. AND SUBSIDIARIES**

 

**CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 
| ** **                                                                                                                                                                                                                                          | ** ** | **December 31,   2003** | ** ** | **September 30,   2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-------------------------------|------------|
| ** **                                                                                                                                                                                                                                          | ** ** | ** **                   | ** ** | ** **                    | ** ** |
| **ASSETS**                                                                                                                                                                                                                                          | ** ** | ** **                   | ** ** | ** **                    | ** ** |
| CURRENT ASSETS:                                                                                                                                                                                                                                     |       |                         |       |                          |       |
| Cash and cash  equivalents                                                                                                                                                                                                                          |       | $                            | 54,562,378 |                          | $          | 51,037,548 |   |
| Other current assets                                                                                                                                                                                                                                |       | 712,673                      |       | 823,511                       |       |
| Total current assets                                                                                                                                                                                                                                |       | 55,275,051                   |       | 51,861,059                    |       |
| PROPERTY AND EQUIPMENT,  At cost:                                                                                                                                                                                                                   |       |                         |       |                          |       |
| Property and equipment  (Note 5)                                                                                                                                                                                                                    |       | 9,959,855                    |       | 16,532,373                    |       |
| Less accumulated  depreciation and amortization                                                                                                                                                                                                     |       | 7,935,450                    |       | 8,788,086                     |       |
| Property and equipment,  net                                                                                                                                                                                                                        |       | 2,024,405                    |       | 7,744,287                     |       |
| OTHER ASSETS                                                                                                                                                                                                                                        |       | 1,624,797                    |       | 1,523,868                     |       |
| TOTAL                                                                                                                                                                                                                                               |       | $                            | 58,924,253 |                          | $          | 61,129,214 |   |
| **LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED  STOCK, AND STOCKHOLDERS’ EQUITY**                                                                                                                                                             | ** ** | ** **                   | ** ** | ** **                    | ** ** |
| CURRENT LIABILITIES:                                                                                                                                                                                                                                |       |                         |       |                          |       |
| Current portion of  long-term obligations (Note 7)                                                                                                                                                                                                  |       | $                            | 884,799    |                          | $          | 592,910 |   |
| Current portion of  deferred revenue                                                                                                                                                                                                                |       | —                       |       | 3,428,571                     |       |
| Accounts payable                                                                                                                                                                                                                                    |       | 1,519,981                    |       | 2,317,199                     |       |
| Accrued expenses                                                                                                                                                                                                                                    |       | 1,939,012                    |       | 2,722,824                     |       |
| Total current  liabilities                                                                                                                                                                                                                          |       | 4,343,792                    |       | 9,061,504                     |       |
| LONG-TERM LIABILITIES:                                                                                                                                                                                                                              |       |                         |       |                          |       |
| Long-term obligations,  net of current portion                                                                                                                                                                                                      |       | 205,418                      |       | 522,887                       |       |
| Deferred revenue, net  of current portion                                                                                                                                                                                                           |       | —                       |       | 714,286                       |       |
| Total long-term  liabilities                                                                                                                                                                                                                        |       | 205,418                      |       | 1,237,173                     |       |
| COMMITMENTS                                                                                                                                                                                                                                         |       |                         |       |                          |       |
| REDEEMABLE CONVERTIBLE  PREFERRED STOCK, authorized, 5,000,000 shares as of December 31, 2003  and September 30, 2004; no shares issued and outstanding as of December 31,  2003 and September 30, 2004                         |       | —                       |       | —                        |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                                                                          |       |                         |       |                          |       |
| Common stock, $0.01 par  value; authorized, 98,500,000 shares as of December 31, 2003 and September 30,  2004; issued and outstanding 14,294,533 shares as of December 31, 2003  and 17,225,927 shares as of September 30, 2004 |       | 142,945                      |       | 172,260                       |       |
| Additional paid-in  capital                                                                                                                                                                                                                         |       | 201,422,784                  |       | 218,153,289                   |       |
| Deferred stock-based  compensation                                                                                                                                                                                                                  |       | (1,723,229                   | )          | (1,165,144                    | )          |
| Accumulated deficit                                                                                                                                                                                                                                 |       | (145,467,457                 | )          | (166,329,868                  | )          |
| Total stockholders’  equity                                                                                                                                                                                                                    |       | 54,375,043                   |       | 50,830,537                    |       |
| TOTAL                                                                                                                                                                                                                                               |       | $                            | 58,924,253 |                          | $          | 61,129,214 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

2

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**ACUSPHERE,INC. AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OFOPERATIONS**

**(Unaudited)**

** **
| ** **                                                    | ** ** | **Three Months Ended**        | ** ** | **Nine Months Ended**         | ** ** |
|---------------------------------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| ** **                                                    | ** ** | **September 30,   2003** | ** ** | **September 30,   2004** | ** ** | **September 30,   2003** | ** ** | **September 30,   2004** | ** ** |
| COLLABORATION REVENUE                                         |       | $                             | —     |                          | $          | 857,143 |   | $ | — |   | $ | 857,143 |   |
| OPERATING EXPENSES:                                           |       |                          |       |                          |       |   |   |   |   |
| Research and  development(1)                                  |       | 3,376,467                     |       | 5,696,622                     |       | 9,624,782 |   | 17,312,511 |   |
| General and  administrative(1)                                |       | 916,449                       |       | 1,358,482                     |       | 2,770,857 |   | 4,028,004 |   |
| Stock-based  compensation                                     |       | 359,975                       |       | 243,159                       |       | 1,071,788 |   | 702,211 |   |
| Total operating  expenses                                     |       | 4,652,891                     |       | 7,298,263                     |       | 13,467,427 |   | 22,042,726 |   |
|                                                          |       |                          |       |                          |       |   |   |   |   |
| Interest income                                               |       | 30,817                        |       | 148,673                       |       | 99,927 |   | 350,207 |   |
| Other income (expense)                                        |       | 37,500                        |       | (6                            | )          | (83,708 | ) | 74,262 |   |
| Interest expense                                              |       | (699,997                      | )          | (26,187                       | )          | (1,740,005 | ) | (101,298 | ) |
| NET LOSS                                                      |       | (5,284,571                    | )          | (6,318,640                    | )          | (15,191,213 | ) | (20,862,412 | ) |
| Accretion of dividends  and offering costs on preferred stock |       | (1,424,853                    | )          | —                        |       | (4,659,798 | ) | — |   |
| NET LOSS AVAILABLE TO  COMMON STOCKHOLDERS                    |       | $                             | (6,709,424 | )                             | $          | (6,318,640 | ) | $ | (19,851,011 | ) | $ | (20,862,412 | ) |
| NET LOSS AVAILABLE TO  COMMON STOCKHOLDERS PER SHARE —   |       |                          |       |                          |       |   |   |   |   |
| Basic and diluted                                             |       | $                             | (3.42      | )                             | $          | (0.39 | ) | $ | (13.59 | ) | $ | (1.40 | ) |
| WEIGHTED-AVERAGE SHARES  OUTSTANDING —                   |       |                          |       |                          |       |   |   |   |   |
| Basic and diluted                                             |       | 1,964,203                     |       | 16,155,990                    |       | 1,460,946 |   | 14,917,465 |   |

 

----

| (1):   | Excludes stock-based  compensation as follows |   |    |    |    |   |    |   |    |      |
|--------|-----------------------------------------------|--------|---------|---------|---------|--------|---------|--------|---------|-----------|
|   | Research and  development                     |   | $       | 161,829 |    | $      | 88,257  |   | $       | 486,857   |   | $ | 267,786 |   |
|   | General and  administrative                   |   | 198,146 |    | 154,902 |   | 584,931 |   | 434,425 |      |
|   |                                          |   | $       | 359,975 |    | $      | 243,159 |   | $       | 1,071,788 |   | $ | 702,211 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

3

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**ACUSPHERE,INC. AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                | ** ** | **Nine Months Ended**        | ** **  |
|---------------------------------------------------------------------------|------------|------------------------------|-------------|
| ** **                                                                | ** ** | **September 30,  2003** | ** **  | **September 30,  2004** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                    |       |                         |        |   |   |
| Net loss                                                                  |       | $                            | (15,191,213 | ) | $ | (20,862,412 | ) |
| Adjustments to  reconcile net loss to cash used in operating activities:  |       |                         |        |   |   |
| Stock-based  compensation expense                                         |       | 1,071,788                    |        | 702,211 |   |
| Depreciation and  amortization                                            |       | 1,411,515                    |        | 942,100 |   |
| Noncash interest  expense                                                 |       | 586,278                      |        | 38,698 |   |
| Noncash rent expense                                                      |       | 40,230                       |        | 116,401 |   |
| Noncash amortization of  deferred revenue                                 |       | —                       |        | (857,143 | ) |
|                                                                      |       |                         |        |   |   |
| Changes in operating  assets and liabilities:                             |       |                         |        |   |   |
| Deferred revenue                                                          |       | —                       |        | 5,000,000 |   |
| Other current assets                                                      |       | (4,910                       | )           | (52,834 | ) |
| Accounts payable                                                          |       | 263,429                      |        | 797,217 |   |
| Accrued expenses                                                          |       | 871,279                      |        | 707,640 |   |
| Net cash used in  operating activities                                    |       | (10,951,604                  | )           | (13,468,122 | ) |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                    |       |                         |        |   |   |
| Purchases of property  and equipment                                      |       | (309,464                     | )           | (6,601,787 | ) |
| Increase in other  assets                                                 |       | (687,937                     | )           | (82,500 | ) |
| Maturities of  short-term investments                                     |       | (1,802,213                   | )           | — |   |
| Net cash used in  investing activities                                    |       | (2,799,614                   | )           | (6,684,287 | ) |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                    |       |                         |        |   |   |
| Payments on long-term  obligations                                        |       | (4,174,086                   | )           | (720,031 | ) |
| Proceeds from long-term  obligations                                      |       | 19,440,342                   |        | 731,913 |   |
| Net proceeds from sale  of common stock in private placement              |       | —                       |        | 16,519,646 |   |
| Net proceeds from  exercise of stock options                              |       | 67,024                       |        | 71,603 |   |
| Proceeds from issuance  of common stock from employee stock purchase plan |       | —                       |        | 24,448 |   |
| Net cash provided by  financing activities                                |       | 15,333,280                   |        | 16,627,579 |   |
| NET INCREASE (DECREASE)  IN CASH AND CASH EQUIVALENTS                     |       | 1,582,062                    |        | (3,524,830 | ) |
| CASH AND CASH  EQUIVALENTS — Beginning of period                     |       | 7,796,238                    |        | 54,562,378 |   |
| CASH AND CASH  EQUIVALENTS — End of period                           |       | $                            | 9,378,300   |   | $ | 51,037,548 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

4

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**ACUSPHERE,INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**1.  Basis of Presentation**

 

Theaccompanying unaudited consolidated financial statements of Acusphere, Inc. andSubsidiaries (the “Company”), have been prepared in accordance with generallyaccepted accounting principles in the United States of America for interimfinancial information and with the instructions to Form 10-Q and Article 10of Regulation S-X. Accordingly, they do not include all of the information andfootnotes required by generally accepted accounting principles in the UnitedStates of America for complete financial statements. These statements should beread in conjunction with the consolidated financial statements and notesthereto included in the Company’s latest audited annual financial statements.Those audited statements are included in our Annual Report on Form 10-K for theyear ended December 31, 2003, which has been filed with the SEC.

 

In theopinion of management, all adjustments, consisting only of normal, recurringadjustments considered necessary for a fair presentation of the results ofthese interim periods have been included. The results of operations for thethree and nine months ended September 30, 2004 may not be indicative ofthe results that may be expected for the full fiscal year.

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements, and the reported amounts of expenses during thereporting period. Actual results could differ from those estimates orassumptions. The more significant estimates reflected in these financialstatements include revenue recognition, accrued expenses and valuation ofstock-based compensation.

 

TheCompany emerged from development stage in July 2004 upon the commencementof its collaboration agreement with Nycomed Danmark ApS (Nycomed).  Accordingly, the Company has removed thecumulative since inception disclosures from the consolidated statements ofoperations and cash flows.

 

**2.  Revenue Recognition**

 

The three months ended September 30,2004 is the first period in which the Company has recognized revenue. TheCompany recognizes revenue from license arrangements in accordance with StaffAccounting Bulletin No. 104, Revenue Recognition (“SAB 104”) and FASB EmergingIssue Task Force Issue No. 00-21, Accounting for Revenue Arrangements withMultiple Deliverables (“EITF 00-21”). The Company recognizes revenue fromlicense payments not tied to achieving a specific performance milestone ratablyover the period over which the Company is obligated to perform services. Theperiod over which the Company is obligated to perform services is estimatedbased on available facts and circumstances. The Company recognizes revenue fromperformance payments, when such performance is substantially in the Company’scontrol and when the Company believes that completion of such performance isreasonably probable, ratably over the period over which the Company estimatesthat it will perform such performance obligations. Substantive at-riskmilestone payments, which are based on achieving a specific performancemilestone when performance of such milestone is contingent on performance byothers or for which achievement can not be reasonably estimated or assured, arerecognized as revenue when the milestone is achieved and the related payment isdue, provided that there is no substantial future service obligation associatedwith the milestone. The Company does not recognize revenue in connection withlicense arrangements until payments are collected or due and reasonably assuredof being collected. In addition, the Company does not recognize revenue incircumstances where the arrangement includes a refund provision until therefund condition is no longer applicable unless, in the Company’s judgment, therefund circumstances are within its operating control and unlikely tooccur.  Payments received in advance ofbeing recognized as revenue are deferred.

 

5

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**3.  Accounting for Stock-based Compensation**

 

TheCompany’s employee stock option plans are accounted for using theintrinsic-value-based method of Accounting Principles Board (“APB”) Opinion No.25, “Accounting for Stock Issued to Employees,” and related interpretations.Accordingly, no compensation expense is recorded for options issued toemployees with fixed amounts and fixed exercise prices which for accountingpurposes are at least equal to the fair value of the Company’s common stock atthe date of grant. Conversely, when the exercise price for accounting purposesis below fair value of the Company’s common stock on the date of grant, anon-cash charge to compensation expense is recorded ratably over the term ofthe option vesting period in an amount equal to the difference between thevalue calculated using the exercise price and the fair value. The Company usesthe fair-value method to account for non-employee stock-based compensation.

 

Stockoptions granted during 2004 were as follows:

 
| ** **                   | ** ** | **Number   of   Shares** | ** ** | **Exercise   Price Per   Share** | ** ** | **Weighted   Average   Exercise   Price Per   Share** | ** ** |
|------------------------------|------------|--------------------------|------------|----------------------------------|------------|-------------------------------------------------------|------------|
| For the three months  ended: |       |                     |       |                             |       |                                                  |       |
| March 31, 2004          |       | 541,139                  |       | $8.50-9.60                       |       | $                                                     | 9.08       |   |
| June 30, 2004           |       | 153,600                  |       | $6.12-7.85                       |       | $                                                     | 6.49       |   |
| September 30, 2004      |       | 73,000                   |       | $6.01-8.07                       |       | $                                                     | 6.60       |   |

 

Thestock options granted in 2004 were granted at fair market value on the date ofgrant.

 

If thecompensation cost for grants issued during the current and prior periods had beendetermined consistent with Statement of Financial Accounting Standard (“SFAS”)No. 123, “Accounting for Stock-based Compensation,” using the fair valuemethod, pro forma net loss and net loss per share would have been thefollowing:

 
| ** **                                                                            | ** ** | **Three Months Ended**        | ** ** | **Nine Months Ended**         | ** ** |
|---------------------------------------------------------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| ** **                                                                            | ** ** | **September 30,   2003** | ** ** | **September 30,   2004** | ** ** | **September 30,   2003** | ** ** | **September 30,   2004** | ** ** |
| Applicable to common  stockholders:                                                   |       |                          |       |                          |       |   |   |   |   |
| Net loss — as reported                                                           |       | $                             | (6,709,424 | )                             | $          | (6,318,640 | ) | $ | (19,851,011 | ) | $ | (20,862,412 | ) |
| Add: Stock-based  employee compensation expense included in reported net loss         |       | 303,327                       |       | 193,234                       |       | 907,778 |   | 583,276 |   |
| Deduct: Stock-based  employee compensation expense determined under fair value method |       | (325,297                      | )          | (456,405                      | )          | (1,333,761 | ) | (1,328,619 | ) |
| Net loss — proforma                                                              |       | $                             | (6,731,394 | )                             | $          | (6,581,811 | ) | $ | (20,276,994 | ) | $ | (21,607,755 | ) |
| Net loss per common  share (basic and diluted):                                       |       |                          |       |                          |       |   |   |   |   |
| As reported                                                                           |       | $                             | (3.42      | )                             | $          | (0.39 | ) | $ | (13.59 | ) | $ | (1.40 | ) |
| Pro forma                                                                             |       | $                             | (3.43      | )                             | $          | (0.41 | ) | $ | (13.88 | ) | $ | (1.45 | ) |

 

**4.  Net Loss Per CommonShare**

 

Basicand diluted net loss per common share is calculated by dividing the net lossapplicable to common stockholders by the weighted-average number ofunrestricted common shares outstanding during the period. Diluted net loss percommon share is the same as basic net loss per common share, since the effectsof potentially dilutive securities are antidilutive for all periods presented.Antidilutive securities, which consist of redeemable convertible preferredstock prior to 2004, stock options, warrants, and restricted common stock thatare not included in the diluted net loss per share calculation, aggregated 7,968,530and 3,006,755 as of September 30, 2003 and 2004, respectively.

 

6

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Thefollowing table reconciles weighted-average common shares outstanding to theshares used in the computation of basic and diluted weighted-average commonshares outstanding:

 
| ** **                                                           | ** ** | **Three Months Ended**        | ** ** | **Nine Months Ended**         | ** ** |
|----------------------------------------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| ** **                                                           | ** ** | **September 30,   2003** | ** ** | **September 30,   2004** | ** ** | **September 30,   2003** | ** ** | **September 30,   2004** | ** ** |
| Weighted-average common  shares Outstanding                          |       | 1,978,800                     |       | 16,164,010                    |       | 1,465,474 |   | 14,927,069 |   |
| Less weighted-average  unvested restricted common shares Outstanding |       | (14,597                       | )          | (8,020                        | )          | (4,528 | ) | (9,604 | ) |
| Basic and diluted  weighted-average common shares outstanding        |       | 1,964,203                     |       | 16,155,990                    |       | 1,460,946 |   | 14,917,465 |   |

 

**5.  Property and Equipment**

 

Propertyand equipment at cost consist of the following:

 
| ** **                       | ** ** | **As of:**                   | ** ** |
|----------------------------------|------------|------------------------------|------------|
| ** **                       | ** ** | **December 31,   2003** | ** ** | **September 30,   2004** | ** ** |
| Equipment                        |       | $                            | 9,655,685  |   | $ | 10,336,997 |   |
| Furniture and fixtures           |       | 181,665                      |       | 198,367 |   |
| Leasehold improvements           |       | 122,505                      |       | 139,997 |   |
| Deposits on equipment  purchases |       | —                       |       | 5,857,012 |   |
| Total property and  equipment    |       | $                            | 9,959,855  |   | $ | 16,532,373 |   |

 

Depositson equipment purchases represent progress payments for long-lead time capitalequipment purchases, the majority of which are associated with development andexpansion of the Company’s manufacturing operations for AI-700.

 

**6.****        Deferred Revenue**

 

 In July 2004, the Company entered into acollaboration, license and supply agreement with Nycomed in which the Companygranted Nycomed rights to develop and market AI-700 in Europe. As part of thisagreement, in July 2004 Nycomed paid the Company a $4.0 million licensefee and the first of eight consecutive quarterly installments of $1.0 millioneach for the Company’s research and development efforts. As of September 30,2004, the Company recognized $857,000 in revenue reflecting an estimated periodof forty-two months over which the $12 million in payments are earned, and $4.1million of such payments were reported by the Company as deferred revenue.

 

**7.  Long-term Obligations**

 

Thecarrying value of long-term obligations was as follows:

 
| ** **                  | ** ** | **As of:**                   | ** ** |
|-----------------------------|------------|------------------------------|------------|
| ** **                  | ** ** | **December 31,   2003** | ** ** | **September 30,   2004** | ** ** |
| Capital lease  obligations  |       | $                            | 1,090,217  |   | $ | 418,119 |   |
| Notes payable               |       | —                       |       | 697,678 |   |
|                        |       | 1,090,217                    |       | 1,115,797 |   |
| Less current maturities     |       | 884,799                      |       | 592,910 |   |
| Long-term obligations,  net |       | $                            | 205,418    |   | $ | 522,887 |   |

 

Long-termobligations, including current maturities, outstanding as of September 30,2004 consisted of capital equipment leased under various capital leasearrangements and promissory notes under the equipment financing line, describedbelow. Monthly payments under the capital lease obligations mature through April 2005.

 

7

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In April 2004,the Company entered into an equipment financing line with an equipment financingcompany. In August 2004, the amount of this equipment financing lineincreased from $8.0 million to $11.3 million.  Borrowings under this equipment line can bemade against qualified purchases approved by the equipment financing company throughMarch 2005. Such borrowings are to be secured by the qualified purchasesand repaid over 36 to 48 months, depending on the nature of the equipmentfinanced. No warrants have been granted in connection with this equipment line.The $11.3 million equipment line is structured as a loan agreement. However,the Company may elect to borrow up to $4.0 million of this amount in the formof a capital lease. The interest rate on this facility varies depending uponwhether the borrowing is in the form of a loan or lease and whether the term is36 months or 48 months. Such interest rates are fixed at the time of eachborrowing under the equipment line with such rates adjusted between borrowingsbased on the U.S. Federal Reserve’s Three Year and Four Year Treasury ConstantMaturity Rates. The loans under this financing line are subject to accelerationupon the happening of certain customary events of default, including failure totimely pay principal and interest. As of September 30, 2004, the Companyhas approximately $10.6 million available in additional borrowings under thisequipment line. Monthly payments for the amounts outstanding under theequipment financing line mature through September 2008.

 

In August 2004,the Company entered into a loan with MassDevelopment under which up to $2.0million of financing is available upon completion by the Company of certaintenant improvements to its commercial manufacturing facility in Tewksbury,Massachusetts. Interest shall accrue under the loan at 5.0% per annum withretroactive adjustments to 9% upon reaching certain defined earning levels. Therepayment of principal and accrued interest will coincide with the term of theTewksbury lease which has a five-year, nine-month term with options to extendthe lease for up to two additional five-year terms. No payments are due underthe loan for the first twenty-four months. Accrued and unpaid interest duringthis twenty-four month period shall be compounded and principal and interestshall be repaid on a monthly basis thereafter such that the total amountoutstanding shall fully amortize over the balance of the term in equalinstallments. The loan is subject to acceleration upon certain customary eventsof default, including failure to timely pay principal and interest. The loan,if utilized, would be secured by certain of the tenant improvements to be madeat the Tewksbury facility. As of September 30, 2004, the Company has $2.0million available to borrow under this financing arrangement, subject to theCompany providing evidence that it has spent at least $2.0 million to makeimprovements to its commercial manufacturing facility.

 

**8.  Stockholders’ Equity**

 

In July 2004,the Company entered into definitive purchase agreements with institutional andaccredited investors for a $21.5 million private placement of up to 3,440,000newly issued shares of common stock at a price of $6.25 per share and warrantsto purchase up to an additional 688,000 shares of common stock at an exerciseprice of $8.50 per share. In August 2004, a partial closing of thisprivate placement was consummated, resulting in aggregate gross proceeds to theCompany of approximately $17.9 million (net proceeds of approximately $16.5million) and the issuance of 2,865,522 shares of common stock and warrants topurchase up to an additional 573,105 shares of common stock.

 

As of September 30,2004, there were 1,166,879 shares of common stock reserved for outstandingstock options previously issued under the Company’s 1994 Stock Plan and 685,455shares common stock reserved for outstanding stock options issued under the2003 Stock Option and Incentive Plan and 1,146,947 shares of common stockreserved for outstanding warrants for the purchase of common stock.

 

**9. Subsequent Events**

 

InOctober 2004, the Company completed the second and final closing of a $21.5million private financing resulting in aggregate gross proceeds to the Companyof approximately $3.6 million (net proceeds of approximately $3.2 million) andthe issuance of 574,478 shares of common stock at a price of $6.25 per shareand warrants to purchase up to an additional 114,895 shares of common stock atan exercise price of $8.50 per share.  Net proceeds from the financing are expected to be used to further fundthe development program for AI-700 and for working capital and generalcorporate purposes.

 

OnNovember 11, 2004, the Company entered into an agency procurement agreementwith Parsons Commercial Technology, Inc. (“Parsons”) authorizing Parsons toprocure as agent to the Company, during the period ending December 10, 2004,manufacturing and other equipment in connection with the build-out of thecommercial manufacturing facility in Tewksbury, Massachusetts.  The total estimated value of equipment to bepurchased under this agreement is $3.9 million.

 

OnNovember 11, 2004, the Company entered into an engineering and constructionmanagement services agreement with Parsons authorizing Parsons to perform onbehalf of the Company, during the period ending December 10, 2004, engineering,design and construction management services in connection with the build-out ofthe commercial manufacturing facility in Tewksbury, Massachusetts.  The total value of this contract is $5.6million.

 

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**ITEM 2.****  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**ForwardLooking Statements May Prove Inaccurate**

 

Fromtime to time, information provided by us, statements made by our employees orinformation included in our filings with the Securities and Exchange Commission(including this quarterly report on Form 10-Q) may contain statements that arenot historical facts, so-called “forward-looking statements,” that involveknown and unknown risks, uncertainties and other factors that may cause ouractual results, performance or achievements to be materially different from anyfuture results, performance or achievements expressed or implied by theseforward-looking statements. Such forward-looking statements are made pursuantto the safe harbor provisions of Section 21E of the Securities ExchangeAct of 1934, as amended.

 

Forward-lookingstatements made in connection with this Form 10-Q include, but are not limitedto our estimates of expenses, staffing and capital requirements and our needand abilities to raise additional financing; statements regarding our recentprivate financing; timing of our clinical trials and regulatory milestones forAI-700; collaborative relationships and related license, development,milestone, manufacturing, royalty and other payments; research and developmentof and commercial prospects for our various product candidates; and ourmanufacturing capabilities and timing of manufacturing production for ourproduct candidates, including statements concerning our new commercial manufacturingspace and related build-out.

 

Insome cases, you can identify forward-looking statements by terms such as “may,”“will,” “should,” “could,” “would,” “expect,” “plans,” “anticipates,” “believes,”“estimates,” “projects,” “predicts,” “intends,” “potential” and similarexpression intended to identify forward-looking statements. These statementsreflect our current views with respect to future events, and are based onassumptions and subject to risks and uncertainties. Also, these forward-lookingstatements represent our estimates and assumptions only as of the date of thisreport. Given these uncertainties, you should not place undue reliance on theseforward-looking statements. When considering forward-looking statements, youshould keep in mind the “Factors That May Affect Future Results” and othercautionary statements included in this report.

 

Youshould read this report with the understanding that our actual future resultsmay be materially different from what we expect. Our business, financial condition,results of operations and prospects may change. We may not update theseforward-looking statements, even though our situation may change in the future,unless we have obligations under the Federal securities laws to update anddisclose material developments related to previously disclosed information. Wequalify all of the information presented in this report, and particularly ourforward-looking statements, by these cautionary statements.

 

**Overview**

 

We area specialty pharmaceutical company that develops new drugs and improvedformulations of existing drugs using our proprietary porous microparticle technology.We are focused on developing proprietary drugs that can offer significantbenefits such as improved safety and efficacy, increased patient compliance,greater ease of use, expanded indications or reduced cost. Our three initialproduct candidates are designed to address large unmet clinical needs withincardiology, oncology and asthma. Our lead product candidate is a cardiovasculardrug in Phase III clinical development for the detection of coronary heartdisease, the leading cause of death in the United States.

 

Wecreated our three initial product candidates using technology that enables usto control the size and porosity of particles in a versatile manner, so we cancustomize the particles to address the delivery needs of a variety of drugs. Weare focused on creating porous microparticles that are smaller than red bloodcells. Some of these microparticles are nanoparticles which are smaller than 1micron. Small microparticles are important for delivering drugs intravenouslyso that they can pass through the body’s smallest blood vessels, for increasingthe surface area of a drug so that the drug will dissolve more rapidly, and fordelivering drugs to the lung via inhalation. Porosity is important forentrapping gases in microparticles, for controlling the release rate of thedrug from a microparticle, and for targeting inhaled drugs to specific regionsof the lung.

 

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We haveincurred significant operating losses to develop our product candidates and weanticipate continuing to incur significant operating losses in the coming yearsto develop our product candidates. In particular, we expect to incursignificant additional expenses and experience other significant capitalrequirements for the conduct of our Phase III clinical program for AI-700 and tocomplete the build-out and qualification, of a manufacturing facility for theinitial commercial manufacture of AI-700.

 

 During the quarter ended September 30,2004, we began to recognize revenues derived from our collaboration withNycomed.  Prior to achieving regulatoryapproval to market and sell AI-700, we anticipate that revenues from thisEurope-focused collaboration will be a small fraction of the overall cost ofdeveloping AI-700 for worldwide use. Since our inception, we have funded ouroperations primarily through private and public placements of equitysecurities, equipment-backed financings and other debt financings.

 

**AI-700Clinical Trial Update**

 

Our Phase III program for AI-700 commenced in 2003under a U.S. Investigational New Drug application (“IND”) and in compliancewith applicable European regulatory requirements. ThePhase III clinical plan provides for a two-part program consisting of a pilotphase, which is designed to qualify and train new investigators and has beencompleted by the majority of the clinical sites, and two multi-center pivotaltrials each for approximately 300 patients with suspected coronary heartdisease. The Phase III pilot and pivotal phase studies are taking place atclinical sites in North America, Europe and Australia with data from the trialsintended for submission to U.S. and European regulatory authorities. We havecumulatively enrolled over 200 patients in the Phase III program. The endpointsfor the trials are sensitivity and specificity in comparison to nuclear stresstesting, angiography or clinical outcome.

 

We aimto cumulatively enroll 300 patients in the Phase III program by the end of 2004and to complete enrollment in the Phase III program by the end of 2005. Our NewDrug Application (“NDA”) filing for AI-700 is planned for 2006, following thebuild-out and qualification of our commercial manufacturing facility. Althoughthese projected enrollment rates, milestones and target completion datesreflect our current plans, we cannot assure you that we will complete theseactivities on this schedule, if at all.

 

**EuropeanCollaboration Agreement**

 

In July 2004, we entered into a collaboration,license and supply agreement with Nycomed pursuant to which we granted Nycomedrights to develop and market AI-700 in Europe. As part of the Agreement,Nycomed has agreed to provide up to $70 million in license fees, researchand development funding, and milestone payments, including $12 million inpayments over the first two years. These near-term payments include $4 millionin upfront license fees and $8 million in research and development fundingpayable in eight equal quarterly installments. The remaining $58 million inmilestone payments are related to regulatory approvals and achievement ofcertain sales goals. In addition, we will be paid to manufacture the productfor Nycomed and will receive royalties on Nycomed’s sales of AI-700. Nycomedwill be responsible for sales, marketing and the regulatory submissionsrequired for marketing throughout its sales territory, which includes themember states of the European Union, as well as Russia/CIS and Turkey.

 

The agreement is subject to termination provisions.  Under certain of these terminationprovisions, if the Company fails in any material respect to use allcommercially reasonable efforts to carry out referenced obligations under theagreement, we would be obligated to pay Nycomed liquidated damages of up to $12million.  We plan to carry out all ofthese obligations, which we believe are in our control.  There can be no assurance that termination ofthis agreement will not occur or that such termination would not result in theCompany incurring liquidated damages of up to $12 million.

 

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**PatentUpdate**

 

During2004, we were issued three additional U.S. patents as follows:

 
| **U.S. Patent No.** | ** ** | **Date Issued**        | ** ** | **Expiration Date**    | ** ** | **Subject**                                                                    | ** ** |
|---------------------|------------|------------------------|------------|------------------------|------------|--------------------------------------------------------------------------------|------------|
| 6,689,390           |       | February 10, 2004 |       | February 22, 2019 |       | Matrices Formed of Polymer and Hydrophobic Compounds  for Use in Drug Delivery |       |
| 6,730,322           |       | May 4, 2004            |       | February 22, 2019 |       | Matrices Formed of Polymer and Hydrophobic Compounds  for Use in Drug Delivery |       |
| 6,800,297           |       | October 5, 2004   |       | November 4, 2019  |       | Porous COX-2 Matrices and Methods of Manufacture  Thereof                      |       |

 

As of November 9,2004, we owned sixteen issued U.S. patents and fifteen U.S. patentapplications. We also own a number of pending international and foreign patentapplications corresponding to these U.S. patents and applications.  We charge all patent-related expenses tooperations as incurred.

 

**FinancialOperations Overview**

 

*Revenue.*  Our product candidates are not yet approvedfor marketing or sale. Beginning in July 2004, we received fees from acollaborative arrangement with Nycomed. A portion of these fees were recognizedas revenue in the quarter ending September 30, 2004. In the future, inaddition to earning additional revenue under our collaborative arrangement withNycomed, we will seek to generate revenue from a combination of product sales,up-front or milestone payments in connection with collaborative or strategicrelationships, and royalties resulting from the license of our products andintellectual property and manufacturing revenue.

 

*Research and Development Expense.*  Research and development expense consists ofexpenses incurred in developing and testing product candidates, including costsassociated with manufacturing product candidates. Research and developmentexpenses consist primarily of salaries and related expenses for personnel, feespaid to professional service providers in conjunction with independentlymonitoring our clinical trials and acquiring and evaluating data in conjunctionwith our clinical trials, costs of contract manufacturing services, costs ofmaterials used in clinical trials and research and development, depreciation ofcapital resources used to develop and manufacture our products, costs of facilitiesand the legal costs of pursuing patent protection on select elements of ourintellectual property. We expense research and development costs, includingpatent related costs, as incurred. We believe that significant investment inproduct development is a competitive necessity and plan to continue theseinvestments in order to realize the potential of our product candidates andproprietary technologies. Development programs for later stage productcandidates, such as AI-700, tend to cost more than earlier stage programs dueto the length and the number of patients enrolled in clinical trials for laterstage programs and due to costs of scaling production to commercial scale.

 

*General and Administrative Expense.*  General and administrative expense consistsprimarily of salaries and other related costs for personnel in executive,finance, accounting, information technology, business development and humanresource functions. Other costs include facility costs not otherwise includedin research and development expense and professional fees for legal andaccounting services.

 

*Stock-Based Compensation Expense.*  Stock-based compensation expense, which is anon-cash charge, results principally from stock option grants to our employeesat exercise prices deemed for accounting purposes to be below the fair marketvalue of our stock on the date the stock options were granted (“fixed awards”).Prior to our initial public offering, which closed on October 14, 2003, wegranted certain stock options for which the exercise prices were deemed foraccounting purposes to be below the fair value of the underlying common stockresulting in our recording stock-based compensation expense associated withsuch grants. Stock-based compensation expense is also recorded for stock optiongrants to non-employees and for restricted stock grants provided to directorsand advisors in lieu of cash compensation. Deferred compensation on fixedawards is amortized as a charge to operations over the vesting periods of theoptions and grants, subject to adjustment for forfeiture during the vestingperiod. As of September 30, 2004, we deferred $1.2 million in stock-basedcompensation.

 

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*Interest and Other Income (Expense).*  Interest income consists of interest earnedon our cash, and cash equivalents. Interest expense consists of interestincurred on equipment leases and on debt financings.

 

*Accretion of Dividends and OfferingCosts on Convertible Preferred Stock.*  Accretion of dividends and offering costs onconvertible preferred stock primarily consists of dividends on convertiblepreferred stock. Prior to conversion of convertible preferred stock to commonstock, which occurred on October 14, 2003 upon the completion of ourinitial public offering, our convertible preferred stock was entitled toaccretion of dividends, the amount of which decreased the amount ofstockholders’ equity available to common stockholders and effectively increasesthe loss per share of common stock. After October 14, 2003, no existingconvertible preferred stock is outstanding, and accordingly there will be nofurther accretion of dividends and offering costs on these shares. Allpreferred stock dividends which were accreted before October 14, 2003 wereforfeited by the preferred stockholders on that date in connection with theconversion of these preferred shares to common stock.

 

**Resultsof Operations**

 

***Three Months Ended September 30, 2003and 2004***

 

*Revenue.***Collaborationrevenue was $857,000 in the three months ended September 30, 2004 comparedto no collaboration revenue recognized in the three months ended September 30,2003.  Collaboration revenue was earnedunder the Company’s agreement with Nycomed which was entered into in July 2004.Under this agreement, the Company is scheduled to receive $12 million inlicense fees and performance payments through June 2006, of which $5.0million has been received through September 30, 2004. The Company isrecognizing revenue associated with these payments ratably over a period of forty-twomonths, representing the estimated development period over which such fees areearned.

 

*Research and Development Expense.*  Research and development expense increased $2.3million, or 69%, to $5.7 million in the three months ended September 30,2004 from $3.4 million in the three months ended September 30, 2003.Research and development expense increased primarily due to increasedactivities in the AI-700 Phase III clinical program, including clinical sitecosts, data management costs and independent clinical monitoring costs. Theincrease in research and development costs also includes costs associated withincreasing our full and part-time personnel and outside consultants.

 

Thefollowing table summarizes the primary components of our research and developmentexpense for the three months ended September 30, 2003 and 2004. Because ofour ability to utilize resources across several projects, many of our researchand development costs are not tied to any individual project and are allocatedamong multiple projects. We record direct costs on a project-by-project basis.We record indirect costs in aggregate in support of all research anddevelopment.

 
| ** **                              | ** ** | **Three Months Ended   September 30,** | ** ** |
|-----------------------------------------|------------|---------------------------------------------|------------|
| ** **                              | ** ** | **2003**                                    | ** ** | **2004** | ** ** |
| ** **                              | ** ** | **(In thousands)**                          | ** ** |
| AI-700                                  |       | $                                           | 2,197      |   | $ | 3,972 |   |
| AI-850 and AI-128                       |       | 155                                         |       | 18 |   |
| Other                                   |       | 193                                         |       | 373 |   |
| Total direct costs                      |       | 2,545                                       |       | 4,363 |   |
| Facility costs and  depreciation        |       | 745                                         |       | 1,070 |   |
| Patent costs                            |       | 86                                          |       | 264 |   |
| Total research and  development expense |       | $                                           | 3,376      |   | $ | 5,697 |   |

 

Researchand development costs generally increase as programs progress from early stageclinical trials to late stage clinical trials. Our primary research anddevelopment programs are as follows:

 

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•             *LateStage Clinical Development Program (AI-700).*  Our lead product candidate, AI-700, is acardiovascular drug for the detection of coronary heart disease. We incurreddirect research and development expense for AI-700 in the three months ended September 30,2004 of $3.9 million compared to $2.2 million in the three months ended September 30,2003. Of these amounts, $200,000 for the three months ended September 30,2004 and $600,000 for the three months ended September 30, 2003 wereincurred in connection with the production of clinical trial material by athird-party contract manufacturer. In 2003, we commenced clinical studies inour Phase III clinical program for AI-700, and we identified and began trainingadditional clinical sites to be part of this Phase III clinical program. Wecommenced the pivotal phase studies of our Phase III clinical program at selectclinical sites in December 2003. As increasing numbers of patients areenrolled in the Phase III clinical program, we anticipate incurring increasedcosts from professional service firms helping to support the clinical trial byproviding services such as independent clinical monitoring, data acquisitionand data evaluation. Such patient enrollment related costs vary from quarter toquarter based upon patient enrollment at the clinical trial sites.  The rate of patient enrollment has beenincreasing during 2004. While we cannot accurately predict the rate of patientenrollment, we may encounter similar variation in such costs until enrollmentin the Phase III clinical program is completed which we estimate will beachieved in the second half of 2005. We also anticipate incurring increasedcosts related to hiring of additional research and development personnel and thecontinued utilization of independent clinical monitors. In addition, we anticipateincurring increased costs associated with preparation for commercialproduction, including completing the build-out and qualification of our newcommercial manufacturing facility.

 

•             *EarlyStage Clinical Development Programs (AI-850 and AI-128).*  Our initial clinical applications of our HDDStechnology, AI-850, and our PDDS technology, AI-128, are in early stages ofclinical development. We incurred direct research and development expense forAI-850 and AI-128 in the three months ended September 30, 2004 of $18,000compared to $155,000 in the three months ended September 30, 2003. Therewere no contract manufacturing costs incurred in connection with these productdevelopment programs during the three months ended September 30, 2004 orthe three months ended September 30, 2003. During 2004, we completed ourPhase I clinical trials for AI-850. We anticipate that our costs associatedwith these clinical programs will not increase significantly until we areprepared to commence further pre-clinical and clinical testing using our ownresources or through strategic collaborations.

 

•             *Other.*  Other direct research and development costsprimarily consist of management and formulation development of other productcandidates.

 

Eachof our research and development programs is subject to risks and uncertainties,including the requirement to seek regulatory approvals, thatare outside of our control. For example, our clinical trials may be subject todelays or rejections based on our inability to enroll patients at the rate thatwe expect or our inability to produce clinical trial material in sufficientquantities and of sufficient quality to meet the schedule for our plannedclinical trials. Moreover, the product candidates identified in these researchand development programs, particularly our early stage programs, must overcomesignificant technological, manufacturing and marketing challenges before theycan be successfully commercialized. As a result of these risks anduncertainties, we are unable to predict with any certainty the period in whichmaterial net cash inflows from such projects could be expected to commence orthe completion date of these programs. Failure to commercialize these productcandidates on a timely basis could have a material adverse affect on ourbusiness, financial condition and results of operations. We may seek toestablish additional collaborative relationships to help us commercialize theseproduct candidates, but there can be no assurance that we will be successful indoing so.

 

*General and Administrative Expense.*  General and administrative expense increased$442,000, or 48%, to $1.4 million in the three months ended September 30,2004 from $916,000 in the three months ended September 30, 2003. Thehigher general and administrative expense incurred in the three months ended September 30,2004 was principally due to the various costs of being a public company,including costs associated with investor relations, legal counsel, insurance, auditingand additional personnel. Also contributing to the higher expenses areincreased activities in business development and marketing, including marketresearch expenses.

 

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*Stock-Based Compensation Expense.*  Stock-based compensation expense decreased $117,000,or 33%, to $243,000 in the three months ended September 30, 2004 from $360,000in the three months ended September 30, 2003. Stock-based compensationexpense incurred in both periods resulted principally from the vesting of stockoptions granted in prior periods on which deferred compensation had previouslybeen recorded and decreased as a result of certain prior year awards becomingfully vested in the current period.

 

*Interest and Other Income (Expense).*  Interest and other income (expense), netincreased $754,000, or 119%, to $122,000 in the three months ended September 30,2004 from a net expense of $632,000 in the three months ended September 30,2003. During these periods, interest and other income (expense) consisted ofthe following:

 
| ** **       | ** ** | **Three Months Ended   September 30,** | ** ** |
|------------------|------------|---------------------------------------------|------------|
| ** **       | ** ** | **2003**                                    | ** ** | **2004** | ** ** |
| Interest income  |       | $                                           | 31,000     |   | $ | 148,000 |   |
| Other income     |       | 37,000                                      |       | — |   |
| Interest expense |       | (700,000                                    | )          | (26,000 | ) |
| Total, net       |       | $                                           | (632,000   | ) | $ | 122,000 |   |

 

Theincrease in interest income in the three months ended September 30, 2004compared to the three months ended September 30, 2003 was primarily due tohigher average fund balances available for investment resulting from fundsreceived from the initial public offering in October 2003 and from fundsreceived from the first closing of the private placement in August 2004.The decrease in interest expense in the three months ended September 30,2004 compared to the three months ended September 30, 2003 was primarilydue to interest costs of $665,000 associated with the bridge loans in the threemonths ended September 30, 2003 compared to zero in the three months endedSeptember 30, 2004. The bridge loans converted into common stock uponcompletion of the Company’s Initial Public Offering on October 14, 2003.In addition to this, the interest expense on the lower capital lease balanceshas decreased $8,000 from the three months ended September 30, 2003compared to the three months ended September 30, 2004.

 

*Accretion of Dividends and OfferingCosts on Convertible Preferred Stock.*  Accretion of dividends and offering costs onconvertible preferred stock decreased $1.4 million, or 100%, to zero in thethree months ended September 30, 2004 from $1.4 million in the threemonths ended September 30, 2003. The decrease was due to the conversion ofall outstanding preferred stock into common stock upon completion of ourinitial public offering on October 14, 2003. All preferred stock dividendswhich were accreted before October 14, 2003 were forfeited by thepreferred stockholders on that date in connection with the conversion of thesepreferred shares to common stock. After October 14, 2003, no existingconvertible preferred stock is outstanding, and accordingly there will be nofurther accretion of dividends and offering costs on these shares.

 

***Nine Months Ended September 30, 2003and 2004***

 

*Revenue.***Collaborationrevenue was $857,000 in the nine months ended September 30, 2004 comparedto no collaboration revenue recognized in the nine months ended September 30,2003.  Collaboration revenue was earnedunder the Company’s agreement with Nycomed which was entered into in July 2004.Under this agreement, the Company is scheduled to receive $12 million inlicense fees and performance payments through June 2006, of which $5.0million has been received through September 30, 2004. The Company isrecognizing revenue associated with these payments ratably over a period offorty-two months, representing the estimated development period over which suchfees are earned.

 

*Research and Development Expense.*  Research and development expense increased $7.7million, or 80%, to $17.3 million in the nine months ended September 30,2004 from $9.6 million in the nine months ended September 30, 2003.Research and development expense increased primarily due to increasedactivities in the AI-700 Phase III clinical program, including clinical sitecosts, data management costs, independent clinical monitoring costs and costsof manufacturing of clinical materials. The increase in research anddevelopment costs also includes costs associated with increasing full andpart-time personnel.

 

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Thefollowing table summarizes the primary components of our research anddevelopment expense for the nine months ended September 30, 2003 and 2004.Because of our ability to utilize resources across several projects, many ofour research and development costs are not tied to any individual project andare allocated among multiple projects. We record direct costs on a project-by-projectbasis. We record indirect costs in aggregate in support of all research anddevelopment.

 
| ** **                              | ** ** | **Nine Months Ended   September 30,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|
| ** **                              | ** ** | **2003**                                   | ** ** | **2004** | ** ** |
| ** **                              | ** ** | **(In thousands)**                         | ** ** |
| AI-700                                  |       | $                                          | 5,503      |   | $ | 12,105 |   |
| AI-850 and AI-128                       |       | 613                                        |       | 145 |   |
| Other                                   |       | 789                                        |       | 1,189 |   |
| Total direct costs                      |       | 6,905                                      |       | 13,439 |   |
| Facility costs and  depreciation        |       | 2,522                                      |       | 3,193 |   |
| Patent costs                            |       | 198                                        |       | 680 |   |
| Total research and  development expense |       | $                                          | 9,625      |   | $ | 17,312 |   |

 

Researchand development costs generally increase as programs progress from early stageclinical trials to late stage clinical trials. Our primary research anddevelopment programs are as follows:

 

•             *LateStage Clinical Development Program (AI-700).*  Our lead product candidate, AI-700, is acardiovascular drug for the detection of coronary heart disease. We incurreddirect research and development expense for AI-700 in the nine months ended September 30,2004 of $12.1 million compared to $5.5 million in the nine months ended September 30,2003. Of these amounts, $1.8 million for the nine months ended September 30,2004 and $1.1 million for the nine months ended September 30, 2003 wereincurred in connection with the production of clinical trial material by athird-party contract manufacturer. In 2003, we commenced clinical studies in ourPhase III clinical program for AI-700, and we identified and began trainingadditional clinical sites to be part of this Phase III clinical program. Wecommenced the pivotal phase studies of our Phase III clinical program at selectclinical sites in December 2003. As increasing numbers of patients areenrolled in the Phase III clinical program, we anticipate incurring increasedcosts from professional service firms helping to support the clinical trial byproviding services such as independent clinical monitoring, data acquisitionand data evaluation. We also anticipate incurring increased costs related tohiring of additional research and development and clinical personnel. Inaddition, we anticipate incurring increased costs associated with preparation forcommercial production, including completing the build-out and qualification ofour new commercial manufacturing facility.

 

•             *EarlyStage Clinical Development Programs (AI-850 and AI-128).*  Our initial clinical applications of our HDDStechnology, AI-850, and our PDDS technology, AI-128, are in early stages ofclinical development. We incurred direct research and development expense forAI-850 and AI-128 in the nine months ended September 30, 2004 of $145,000compared to $613,000 in the nine months ended September 30, 2003. Therewere no contract manufacturing costs incurred in connection with these productdevelopment programs during the nine months ended September 30, 2004 orthe nine months ended September 30, 2003. During 2004, we completed ourPhase I clinical trials for AI-850. We anticipate that our costs associatedwith these clinical programs will not increase significantly until we areprepared to commence further pre-clinical and clinical testing using our ownresources or through strategic collaborations.

 

•             *Other.*  Other direct research and development costsprimarily consist of management and formulation development of other productcandidates.

 

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Eachof our research and development programs are subjectto risks and uncertainties, including the requirement to seek regulatoryapprovals, which are outside of our control. For example, our clinical trialsmay be subject to delays or rejections based on our inability to enrollpatients at the rate that we expect or our inability to produce clinical trialmaterial in sufficient quantities and of sufficient quality to meet the schedule forour planned clinical trials. Moreover, the product candidates identified inthese research and development programs, particularly our early stage programs,must overcome significant technological, manufacturing and marketing challengesbefore they can be successfully commercialized. As a result of these risks anduncertainties, we are unable to predict with any certainty the period in whichmaterial net cash inflows from such projects could be expected to commence orthe completion date of these programs. Failure to commercialize these productcandidates on a timely basis could have a material adverse affect on our business,financial condition and results of operations. We may seek to establishadditional collaborative relationships to help us commercialize these productcandidates, but there can be no assurance that we will be successful in doingso.

 

*General and Administrative Expense.*  General and administrative expense increased$1.3 million, or 45%, to $4.0 million in the nine months ended September 30,2004 from $2.8 million in the nine months ended September 30, 2003. Thehigher general and administrative expense incurred in the nine months ended September 30,2004 was principally due to the various costs of being a public company,including costs associated with investor relations, legal counsel, insurance, auditingand additional personnel. Also contributing to the higher expenses areincreased activities in business development and marketing, including marketresearch expenses.

 

*Stock-Based Compensation Expense.*  Stock-based compensation expense decreased $369,000,or 35%, to $702,000 in the nine months ended September 30, 2004 from $1.1million in the nine months ended September 30, 2003. Stock-basedcompensation expense incurred in both periods resulted principally from thevesting of stock options granted in prior periods on which deferredcompensation had previously been recorded and decreased as a result of certainprior year awards becoming fully vested in the current period.

 

*Interest and Other Income (Expense).*  Interest and other income (expense), netincreased $2.0 million, or 119%, to $323,000 in the nine months ended September 30,2004 from a net expense of $1.7 million in the nine months ended September 30,2003. During these periods, interest and other income (expense) consisted ofthe following:

 
| ** **             | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------|------------|------------------------------------------|------------|
| ** **             | ** ** | **2003**                                 | ** ** | **2004** | ** ** |
| Interest income        |       | $                                        | 100,000    |   | $ | 350,000 |   |
| Other income (expense) |       | (84,000                                  | )          | 74,000 |   |
| Interest expense       |       | (1,740,000                               | )          | (101,000 | ) |
| Total, net             |       | $                                        | (1,724,000 | ) | $ | 323,000 |   |

 

Theincrease in interest income in the nine months ended September 30, 2004compared to the nine months ended September 30, 2003 was primarily due tohigher average fund balances available for investment resulting from fundsreceived from the initial public offering in October 2003 and from fundsreceived from the first closing of our private placement in August 2004.The decrease in interest expense in the nine months ended September 30,2004 compared to the nine months ended September 30, 2003 was primarilydue to interest costs associated with the bridge loans of $1.3 million,interest paid on the subordinated loans payable of $195,000, amortization ofthe discount of $108,000 and amortization of legal fees on the subordinatedloans of $35,000 in the nine months ended September 30, 2003 compared tozero in the nine months ended September 30, 2004. The subordinated loanswere paid off in June of 2003 and the bridge loans converted into commonstock upon completion of the Company’s Initial Public Offering on October 14,2003. In addition to this, the interest expense on the lower capital lease balanceshas decreased $63,000 from the nine months ended September 30, 2003compared to the nine months ended September 30, 2004.

 

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*Accretion of Dividends and OfferingCosts on Convertible Preferred Stock.*  Accretion of dividends and offering costs onconvertible preferred stock decreased $4.7 million, or 100%, to zero in the ninemonths ended September 30, 2004 from $4.7 million in the nine months endedSeptember 30, 2003. The decrease was primarily due to the conversion ofall outstanding preferred stock into common stock upon completion of ourinitial public offering on October 14, 2003. All preferred stock dividendswhich were accreted before October 14, 2003 were forfeited by thepreferred stockholders on that date in connection with the conversion of thesepreferred shares to common stock. After October 14, 2003, no existingconvertible preferred stock is outstanding, and accordingly there will be nofurther accretion of dividends and offering costs on these shares.

 

**Liquidityand Capital Resources**

 

Historically,we have financed our business through the issuance of equity securities, debtfinancings and equipment leases. Our liquidity requirements have arisenprimarily from research and development expenditures, equipment expendituresand payments on outstanding indebtedness. As of September 30, 2004, we hadcash and cash equivalents of $51.0 million. As of September 30, 2004 weowed $418,000 from capital leases, $698,000 from notes payable and had commitmentstotaling $27.1 million, including $20.4 million for rent under our facilityleases. Our facility leases consist of our lease for our headquarters facilityin Watertown, Massachusetts and a lease agreement signed in July 2004 for ourcommercial manufacturing facility in Tewksbury, Massachusetts.

 

Duringthe nine months ended September 30, 2004, operating activities used $13.5million of cash. Net cash used by operating activities during this periodresulted primarily from a net loss of $20.9 million. This use of cash waspartially offset by an increase in deferred revenue of $5.0 million, anincrease in accrued expenses of $708,000, an increase in accounts payable of $797,000and non-cash charges of $942,000.

 

Duringthe nine months ended September 30, 2004, investing activities used $6.7million in cash. This use of cash was principally for purchases of equipment.

 

Duringthe nine months ended September 30, 2004, financing activities provided $16.6million in net cash. Net cash provided by financing activities during thisperiod resulted primarily from the first closing of the private placement in August 2004of $16.5 million, net of $1.4 million in offering and registration related costs.Net cash provided by financing activities during this period also resulted fromentering into promissory notes under the equipment financing line, describedbelow, of $732,000, proceeds from stock option exercises of $72,000 andproceeds from the sale of common stock through the Company’s Employee StockPurchase Plan of $24,000. These proceeds were partially offset by payments onthe capital leases and promissory notes of $720,000.

 

In April 2004,the Company entered into an equipment financing line with an equipmentfinancing company. In August 2004, the amount of this equipment financingline increased from $8.0 million to $11.3 million.  Borrowings under this equipment line can bemade against qualified purchases approved by the equipment financing company throughMarch 2005. Such borrowings are to be secured by the qualified purchasesand repaid over 36 to 48 months, depending on the nature of the equipmentfinanced. No warrants were granted in connection with this equipment line. The$11.3 million equipment line is structured as a loan agreement. However, theCompany may elect to borrow up to $4.0 million of this amount in the form of acapital lease. The interest rate on this facility varies depending upon whetherthe borrowing is in the form of a loan or lease and whether the term is 36months or 48 months. Such interest rates are fixed at the time of eachborrowing under the equipment line with such rates adjusted between borrowingsbased on the U.S. Federal Reserve’s Three Year and Four Year Treasury ConstantMaturity Rates. As of September 30, 2004, the Company has approximately$10.6 million available in additional borrowings under this equipment line.

 

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In July 2004,the Company entered into a collaboration, license and supply agreement withNycomed in which the Company granted Nycomed rights to develop and marketAI-700 in Europe. As part of this agreement, in July 2004 Nycomed paid theCompany a $4.0 million license fee and the first of eight consecutive quarterlyinstallments of $1.0 million each. Beginning in October 2004, Nycomed isrequired to pay the Company the remaining seven consecutive quarterlyinstallments of $1.0 million each. The agreement also provides for Nycomed topay the Company up to $58.0 million in milestone payments upon achievement ofcertain regulatory milestones and sales goals. Under the agreement, the Companywill also be paid to manufacture AI-700 for Nycomed and is entitled toroyalties on Nycomed’s sales of AI-700. In connection with this agreement, theCompany is obligated to pay a customary fee to its financial advisor in thistransaction. The total fee, of which $325,000 was paid by the Company duringthe three months ended September 30, 2004, is comprised of cash andwarrants and is dependent upon the timing and magnitude of the amounts to bepaid by Nycomed to the Company.

 

In July 2004,the Company entered into a lease agreement for 58,000 square feet of commercialmanufacturing space in Tewksbury, Massachusetts. This lease has a five year,nine month term with options to extend the lease for up to two additionalfive-year terms at predetermined rental rates. Initially, Acusphere willreceive nine months of occupancy free of base rent, followed by base rent ofapproximately $400,000 for the next twelve months with scheduled annual rentalrate increases thereafter. An initial security deposit of $1.0 million isrequired as part of the lease, subject to reduction upon the Company making atleast $5.0 million in certain tenant improvements in the facility.

 

In September 2004,the Company began efforts to build-out this facility to meet the initialcommercial manufacturing requirements of AI-700. The Company estimates thatover the two year period beginning in July 2004, it may spend an aggregateof approximately $20 million, excluding the cost of our manufacturingequipment, to build-out the Tewksbury facility. During the three months ended September 30,2004, the Company paid $436,000 for initial design and construction activitiesassociated with this build-out.

 

InNovember 2004, in connection with the build-out of the Tewksbury facility, theCompany entered into an agency procurement agreement with a contractor coveringthe purchase during the period ending December 10, 2004 of equipment having anestimated value of $3.9 million, and an engineering and construction managementservices agreement with the same contractor covering the provision during theperiod ending December 31, 2004 of engineering, design and constructionmanagement services for $5.6 million.

 

In August 2004,the Company entered into a $2.0 million loan agreement with the MassachusettsDevelopment Finance Agency, the economic development authority of theCommonwealth of Massachusetts, to help fund build-out costs related to theTewksbury facility. Financing is available under this loan agreement uponcompletion by the Company of certain tenant improvements to the Tewksburyfacility. The term of this facility, if utilized, is expected to coincide withthe term of the Tewksbury lease.

 

Historically,Company personnel have manufactured AI-700 at a manufacturing facility operatedby a third-party contract manufacturer. The Company anticipates completing themanufacture of AI-700 clinical trial material at that site, and removing itsequipment from that site, in early 2005.

 

In July 2004,the Company entered into definitive purchase agreements with institutional andaccredited investors for a $21.5 million private placement of up to 3,440,000newly issued shares of common stock at a price of $6.25 per share and warrantsto purchase up to an additional 688,000 shares of common stock at an exerciseprice of $8.50 per share. In August 2004, a partial closing of thisprivate placement was consummated, resulting in proceeds to the Company ofapproximately $16.5 million, net of offering and registration related costs of$1.4 million, and the issuance of 2,865,522 shares of common stock and warrantsto purchase up to an additional 573,105 shares of common stock.

 

In October 2004,the Company completed a second and final closing of this private financing. Thesecond closing resulted in proceeds to the Company of approximately $3.2million, net of estimated offering and registration related costs of $400,000,and the issuance of 574,478 shares of common stock at a price of $6.25 pershare and warrants to purchase up to an additional 114,895 shares of commonstock at an exercise price of $8.50 per share.

 

Netproceeds from the financing are expected to be used to further fund thedevelopment program for AI-700 and for working capital and general corporatepurposes.

 

Theshares of common stock and warrants sold in the private placement have not beenregistered under the Securities Act of 1933, as amended,or state securities laws and may not be offered or sold in the United Statesabsent registration with the Securities and Exchange Commission or anapplicable exemption from these registration requirements. The Company hasagreed to file a registration statement with the Securities and ExchangeCommission to cover the resale of the shares of common stock issued in theprivate placement and the shares of common stock issued upon exercise of thewarrants.

 

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Webelieve, based on our operating plans, that our existing resources, includingscheduled payments from Nycomed, will be sufficient to fund our plannedoperations, including increases in spending for our AI-700 Phase III clinicalprogram and capital spending associated with our manufacturing operations, forat least the next twelve months. However, over the next several years we will requiresignificant additional funds to develop, conduct clinical trials, achieveregulatory approvals, build-out commercial manufacturing space and, subject toregulatory approval, commercially launch AI-700, our other product candidatesunder development and future product candidates. Our future capitalrequirements will depend on many factors, including the scope and progress madein our research and development activities and our clinical trials and the sizeand timing of creating expanded manufacturing capabilities. We may also needadditional funds for possible future strategic acquisitions of businesses,products or technologies complementary to our business. We do not expect togenerate significant revenues, other than possible license or milestonepayments, from commercial sale of our products unless or until we or current orpotential partners complete clinical trials for our products and receivemarketing approval from the applicable regulatory authorities. If additionalfunds are required, we may raise such funds from time to time through public orprivate sales of equity or from borrowings. Financing may not be available onacceptable terms, or at all, and our failure to raise capital when needed couldmaterially adversely impact our growth plans and our financial condition andresults of operations. Additional equity financing may be dilutive to theholders of our common stock and debt financing, if available, may involvesignificant cash payment obligations and covenants that restrict our ability tooperate our business.

 

**ContractualObligations**

 

Thefollowing table summarizes our contractual obligations as of September 30,2004 and the effect such obligations are expected to have on our liquidity andcash flow in future periods:

 

**PaymentsDue by Period**

 
| ** **                                                        | ** ** | **Total Obligations   All Years** | ** ** | **Remainder   of 2004** | ** ** | **2005   through   2006** | ** ** | **2007   through   2008** | ** ** | **2009   through   2010** | ** ** | **After   2010** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------------|------------|-------------------------|------------|---------------------------|------------|---------------------------|------------|---------------------------|------------|------------------|------------|
| ** **                                                        | ** ** | **(In thousands)**                | ** ** |
| Capital lease  obligations, including interest                    |       | $                                 | 439        |                    | $          | 224                       |       | $                         | 215        |                      | $          | —           |       | $ | — |   | $ | — |   |
| Operating lease  obligations                                      |       | 20,438                            |       | 536                     |       | 5,239                     |       | 5,911                     |       | 6,022                     |       | 2,730            |       |
| Notes payable,  including interest                                |       | 820                               |       | 58                      |       | 460                       |       | 302                       |       | —                    |       | —           |       |
| Purchase orders for  capital equipment and leasehold improvements |       | 5,444                             |       | 3,448                   |       | 1,996                     |       | —                    |       | —                    |       | —           |       |
| Total contractual cash  obligations                               |       | $                                 | 27,141     |                    | $          | 4,266                     |       | $                         | 7,910      |                      | $          | 6,213            |       | $ | 6,022 |   | $ | 2,730 |   |

 

As of September 30,2004, we have entered into purchase orders for capital equipment and leaseholdimprovements, associated with our manufacturing operations, which totalapproximately $11.0 million. Against these purchase orders we have paidapproximately $5.6 million in deposits. The table above reflects the remainingamounts due on these purchase orders.

 

Asubstantial portion of the capital equipment purchase in the table above is forequipment needed for expanded manufacturing of AI-700. The Company’s efforts to build-out a commercial manufacturing facility for AI-700is in the detailed design and early construction phase. The purchaseorders for leasehold improvements included in the above table reflect open purchaseorders issued by the Company as of September 30, 2004 for these initialbuild-out efforts.  In November 2004,the Company entered into an agreement with a contractor to further the designand construction associated with the build-out of the commercial manufacturingfacility. This contract, the total value of which is $5.6 million, covers thework to be performed by this contractor during 2004, of which the Company paid$436,000 prior to September 30, 2004.

 

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**CriticalAccounting Policies and Estimates**

 

Ourdiscussion and analysis of our financial condition and results of operationsare based on our consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United States.The preparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities and expenses.On an on-going basis, we evaluate our estimates and judgments, including thoserelated to accrued expenses, fair valuation of stock related to stock-basedcompensation and income taxes. We based our estimates on historical experience andon various other assumptions that we believe to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not readily apparentfrom other sources. Actual results may differ from these estimates underdifferent assumptions or conditions.

 

Webelieve the following critical accounting policies affect our more significantjudgments and estimates used in the preparation of our consolidated financialstatements.

 

*      Revenue Recognition.* The Company isrecognizing collaboration revenue of $12.0 million associated with the initiallicense and performance-based payments under the Nycomed agreement based on anestimated recognition period of forty-two months over which the Company isobligated to perform services supporting the agreement.  This estimated recognition period may change ifavailable facts and circumstances change. A change in this estimate could result in a significant change to theamount of revenue recognized in future periods. In addition, if the Nycomed collaboration agreement is terminated forreasons other than certain non-performance of the Company, the Company wouldrecognize the remainder of the payments that it has received or otherwise expectsto collect over the amortization period at the time of termination.

 

*Accrued Expenses.*  As part of the process of preparingconsolidated financial statements we are required to estimate accrued expenses.This process involves identifying services which have been performed on ourbehalf and estimating the level of service performed and the associated costincurred for such service as of each balance sheet date in our consolidatedfinancial statements. Examples of estimated expenses for which we accrue includeprofessional service fees, such as lawyers and accountants, and contractservice fees such as amounts paid to clinical monitors, data managementorganizations and investigators in conjunction with clinical trials, and feespaid to contract manufacturers in conjunction with the production of clinicalmaterials. In connection with such service fees, our estimates are mostaffected by our understanding of the status and timing of services providedrelative to the actual levels of services incurred by such service providers.The majority of our service providers invoice us monthly in arrears forservices performed. In the event that we do not identify certain costs whichhave begun to be incurred or we under- or over-estimate the level of servicesperformed or the costs of such services, our reported expenses for such periodwould be too low or too high. The date on whichcertain services commence, the level of services performed on or before a givendate and the cost of such services are often judgmental. We make thesejudgments based upon the facts and circumstances known to us in accordance withgenerally accepted accounting principles.

 

*Stock-Based Compensation and OtherEquity Instruments.* We have elected to follow APB Opinion No. 25, *Accounting for Stock Issued to Employees*, and relatedinterpretations, in accounting for our stock-based compensation plans, ratherthan the alternative fair value accounting method provided for under SFAS No.123, *Accounting for Stock-Based Compensation*.Accordingly, we have not recorded stock-based compensation expense for stockoptions issued to employees in fixed amounts with exercise prices at leastequal to the fair value of the underlying common stock on the date of grant. Inthe notes to our consolidated financial statements we provide pro formadisclosures in accordance with SFAS No. 123 and related pronouncements. Weaccount for transactions in which services are received in exchange for equityinstruments based on the fair value of such services received from non-employeesor of the equity instruments issued, whichever is more reliably measured, inaccordance with SFAS No. 123 and EITF Issue No. 96-18, *Accounting for Equity Instruments that Are Issued toOther than Employees for Acquiring, or in Conjunction with Selling, Goods orServices*. We account for transactions in which we grant warrants inconnection with the issuance of debt in accordance with APB 14, *Accounting for Convertible Debt and Debt Issued withStock Purchase Warrants*. The two factors which most affect chargesor credits to operations related to stock-based compensation are the fair valueof the common stock underlying stock options for which stock-based compensationis recorded and the volatility of such fair value.

 

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Accounting forequity instruments granted or sold by us under APB No. 14, APB No. 25, SFAS No.123 and EITF No. 96-18 requires fair value estimates of the equity instrumentgranted or sold. If our estimates of the fair value of these equity instrumentsare too high or too low, it would have the effect of overstating orunderstating expenses. When equity instruments are granted or sold in exchangefor the receipt of goods or services and the value of those goods or servicescan be readily estimated, we use the value of such goods or services todetermine the fair value of the equity instruments. When equity instruments aregranted or sold in exchange for the receipt of goods or services and the valueof those goods or services can not be readily estimated, as is true inconnection with most stock options and warrants granted to employees ornon-employees, we estimated the fair value of the equity instruments based uponconsideration of factors which we deemed to be relevant at the time using cost,market and/or income approaches to such valuations. Because shares of ourcommon stock were not publicly traded prior to our initial public offering inOctober 2003, market factors historically considered in valuing stock and stockoption grants included comparative values of public companies discounted forthe risk and limited liquidity provided for in the shares we are issuing,pricing of private sales of our convertible preferred stock, prior valuationsof stock grants and the effect of events that have occurred between the time ofsuch grants, economic trends, perspective provided by investment banks and thecomparative rights and preferences of the security being granted compared tothe rights and preferences of our other outstanding equity.

 

*IncomeTaxes.*  As part of theprocess of preparing our consolidated financial statements we are required toestimate our income taxes in each of the jurisdictions in which we operate.This process involves estimating our actual current tax exposure together withassessing temporary differences resulting from differing treatments of itemsfor tax and accounting purposes. These differences result in deferred taxassets and liabilities. In addition, as of December 31, 2003, we had federaltax net operating loss carryforwards of $68.5 million, which expire through2023. We also have research and development credit carryforwards of $2.6million. We have recorded a valuation allowance to fully offset against theseotherwise recognizable net deferred tax assets due to the uncertainty surroundingthe timing of the realization of the tax benefit. In the event that wedetermine in the future that we will be able to realize all or a portion of itsnet deferred tax benefit, an adjustment to deferred tax valuation allowancewould increase net income in the period in which such a determination is made.The Tax Reform Act of 1986 contains provisions that may limit the utilizationof net operating loss carryforwards and credits available to be used in anygiven year in the event of significant changes in ownership interest, asdefined.

 

**CertainFactors Which May Affect Future Results**

 

*Ouroperating results and financial condition have varied in the past and may inthe future vary significantly depending on a number of factors. Except for thehistorical information in this report, the matters contained in this reportinclude forward-looking statements that involve risks and uncertainties. Thefollowing factors, among others, could cause actual results to differmaterially from those contained in forward-looking statements made in thisreport and presented elsewhere by management from time to time. Such factors,among others, may have a material adverse effect upon our business, results ofoperations and financial condition.*

 

**Risks Related to Our Company**

 

***We have not generated any product revenue to date, and wemay not achieve profitability for some time, if at all.***

 

We are focused on product development and we have notgenerated any revenue from commercial sales of our products to date. We haveincurred losses each year of our operations and we expect to continue to incuroperating losses for the next several years. The process of developing ourproducts requires significant clinical, development and laboratory testing andclinical trials as well as regulatory approvals. In addition, commercializationof our product candidates will require us to establish sales, marketing andmanufacturing capabilities, either through internal hiring or throughcontractual relationships with others. We expect our research and developmentand general and administrative expenses will increase over the next severalyears.

 

***If we fail toobtain regulatory approvals for our product candidates under development, andin particular our lead product candidate AI-700, we will not be able togenerate revenues from the commercialization or sale of our product candidates.***

 

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We must receive regulatory approval of each of ourproduct candidates before we can commercialize or sell that product candidate.The pre-clinical laboratory testing, formulation development, manufacturing andclinical trials of any product candidates we develop independently or incollaboration with third parties, as well as the distribution and marketing ofthese product candidates, are regulated by numerous federal, state and localgovernmental authorities in the United States, principally the FDA, and bysimilar agencies in other countries. The development and regulatory approvalprocess takes many years, requires the expenditure of substantial resources, isuncertain and subject to delays, and will thus delay our receipt of revenues,if any, from any of our product candidates. We cannot assure you that ourclinical trials will demonstrate the safety and efficacy of any of our productcandidates or will result in marketable products.

 

No product can receive FDA approval unless humanclinical trials show both safety and efficacy for each target indication inaccordance with FDA standards. A number of companies in the pharmaceutical andbiotechnology industries have suffered significant setbacks in late stageclinical trials even after achieving promising results in early stagedevelopment. We therefore cannot assure you that the results from our Phase IIclinical trials for AI-700 will be predictive of results obtained in our PhaseIII clinical trials. Many of the patients in our AI-700 clinical trial havecoronary heart disease. As part of our AI-700 Phase III clinical trials,patients will be exposed to potential safety risks associated with a stresstest, including risks associated with a pharmacological stressor, and AI-700.Given the nature of the AI-700 Phase III clinical trial, includingadministering AI-700 to larger numbers of at-risk patients and new clinicalsites, adverse events are expected to be encountered during the clinical trial.Adverse events are also likely to be encountered in clinical trials for ourother products, which clinical trials also include at-risk patients. Ifsignificant adverse events are detected and these events are attributable toour products, such events could delay, limit or prevent regulatory agencyapproval. Further, data obtained from pre-clinical and clinical activities aresubject to varying interpretations that could delay, limit or preventregulatory agency approval. We cannot assure you that our Phase III plan forAI-700 will successfully address the concerns of the FDA or that the results ofthe Phase III program will establish the safety and efficacy of AI-700 sufficientlyfor us to obtain regulatory approval.

 

We may also encounter delays or rejections based onour inability to enroll enough patients to complete our clinical trials. We mayalso encounter delays, resulting from the need to enroll more patients than expectedin our clinical trials, based on our inability to enroll a mix of patients thatis consistent with our estimated clinical trial enrollment. Patient enrollmentdepends on many factors, including the size of the patient population, thenature of the protocol, the proximity of patients to clinical sites, and theeligibility criteria for the study and the freedom to operate with respect tointellectual property. Delays in planned patient enrollment, or the need toenroll more patients, may result in increased costs and delays, which couldhave a harmful effect on our ability to develop products. We may encounterdelays or rejections based on changes in regulatory agency policies during theperiod in which we develop a drug or the period required for review of anyapplication for regulatory agency approval of a particular compound. OnMay 1, 2004, changes went into effect in the regulation of clinical trialsin Europe. Implementation of these changes could lead to delays to our clinicaltrials. We also may encounter delays in the event we are unable to produceclinical trial material in sufficient quantities and of sufficient quality tomeet the schedule for our planned clinical trials. In addition, we rely on anumber of third parties, such as clinical research organizations, to helpsupport the clinical trials by performing independent clinical monitoring, dataacquisition and data evaluations. Any failure on the part of these thirdparties could delay the regulatory approval process.

 

Failure to obtain regulatory approval or any delay orsetback in obtaining regulatory agency approvals could:

 

•                                          adverselyaffect our ability to market any drugs we develop independently or withcollaborative partners;

 

•                                          imposeadditional costs and diminish any competitive advantages that we may attain; or

 

•                                          adverselyaffect our ability to generate royalties.

 

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In particular, failure to obtain approval or substantial delays inobtaining approval for our lead product candidate, AI-700, would delay ourreceipt of product revenues and materially adversely affect our business,financial condition and results of operations.

 

We cannot be certain that we will obtain anyregulatory approvals in other countries and the failure to obtain theseapprovals may materially adversely affect our business, financial condition andresults of operations. In order to market our products outside of the UnitedStates, we and our current, and potential future, collaborative partners mustestablish and comply with numerous and varying regulatory requirements of othercountries regarding safety and efficacy. The approval procedures vary amongcountries and can involve additional product testing and additionaladministrative review periods. The time required to obtain approval in othercountries might differ from that required to obtain FDA approval. Theregulatory approval process in other countries may include all of the risksassociated with obtaining FDA approval detailed above. Approval by the FDA doesnot ensure approval by the regulatory authorities of other countries. Inaddition, many countries outside the United States require a separate reviewprocess prior to marketing to determine whether their national health insurancescheme will pay for newly approved products, as well as the price which may becharged for a product.

 

***Our products, if approved, may fail to achieve marketacceptance.***

 

There can be no assurance that any products wesuccessfully develop, if approved for marketing, will achieve market acceptanceor generate significant revenues. Each of our product candidates is intended toreplace or alter existing therapies or procedures, and hospitals, physicians orpatients may conclude that these products are less safe or effective or otherwiseless attractive than these existing therapies or procedures. For example, ourlead product candidate, AI-700, is a contrast agent for use in ultrasoundimaging procedures which will compete with existing nuclear imaging and stressechocardiography. Hospitals, physicians or patients may prefer these existingprocedures to AI-700 enhanced ultrasound imaging. If our products do notreceive market acceptance for any reason, it would adversely affect ourbusiness, financial condition and results of operations.

 

Further, our competitors may develop new technologiesor products that are more effective or less costly, or that seem morecost-effective, than our products. We can give no assurance that hospitals,physicians, patients or the medical community in general will accept and useany products that we may develop.

*** ***

***If we cannot raise additional capital on acceptable terms,we may be unable to complete planned clinical trials, obtain regulatoryapprovals or commercialize our product candidates.***

 

We will require substantial future capital in order tocontinue to conduct the research and development, clinical and regulatoryactivities necessary to bring our product candidates to market and to establishcommercial manufacturing, marketing and sales capabilities. Our future capitalrequirements will depend on many factors, including:

 

•                                          theprogress of pre-clinical development and laboratory testing and clinicaltrials;

 

•                                          thetiming of construction and size to which we expand our manufacturingcapabilities;

 

•                                          thetime and costs involved in obtaining regulatory approvals;

 

•                                          thenumber of product candidates we pursue;

 

•                                          thecosts involved in filing and prosecuting patent applications and enforcing ordefending patent claims; and

 

•                                          theestablishment of selected strategic alliances and activities required forproduct commercialization.

 

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We intend to seek additional funding through strategiccollaborations and may seek funding through private or public sales of our securitiesor by licensing all or a portion of our technology. This funding maysignificantly dilute existing stockholders or may limit our rights to ourtechnology.

 

We cannot assure you that we can obtain additionalfunding on reasonable terms, or at all. If we cannot obtain adequate funds, wemay:

 

•                                          terminateor delay clinical trials for one or more of our product candidates;

 

•                                          delayour establishment of sales, marketing and/or manufacturing capabilities;

 

•                                          curtailsignificant product development programs that are designed to identify newproduct candidates;

 

•                                          relinquishrights to our technologies or product candidates; and/or

 

•                                          terminateor delay build-out and commissioning of our commercial manufacturing facility.

 

***Claims by other companies that we infringe their proprietarytechnology may result in liability for damages or stop our development andcommercialization efforts.***

 

Competitors and other third parties may initiatepatent litigation against us in the United States or in foreign countries basedon existing patents or patents that may be granted in the future. Many of ourcompetitors have obtained patents covering products and processes generallyrelated to our products and processes, and they may assert these patentsagainst us. Moreover, there can be no assurance that these competitors have notsought or will not seek additional patents that may cover aspects of ourtechnology. As a result, there is a greater likelihood of a patent dispute thanwould be expected if our competitors were pursuing unrelated technologies.

 

While we conduct patent searches to determine whetherthe technologies used in our products infringe patents held by third parties,numerous patent applications are currently pending and may be filed in thefuture for technologies generally related to our technologies, including manypatent applications that remain confidential after filing. Due to these factorsand the inherent uncertainty in conducting patent searches, there can be noguarantee that we will not violate third-party patent rights that we have notyet identified.

 

We know of U.S. and foreign patents issued to thirdparties that relate to aspects of our product candidates. There may also bepatent applications filed by these or other parties in the United States andvarious foreign jurisdictions that relate to some aspects of our productcandidates, which, if issued, could subject us to infringement actions. Inparticular, we are aware of U.S. and foreign patents owned by third parties,including potential competitors, that arguably cover aspects of our AI-700contrast agent. We and several of these parties have recently been activelyengaged in opposing the grant of European patents with claims that arguablycover aspects of our AI-700 product. Parties may contest patents in Europeprior to contesting the counterpart patents in the United States because ofprocedural differences between European and U.S. patent laws as well aseconomic considerations. There is a significant possibility that one or more ofthese third parties will use litigation to assert their patents in the UnitedStates or Europe.

 

The owners or licensees of these and other patents mayfile one or more infringement actions against us. In addition, a competitor mayclaim misappropriation of a trade secret by an employee hired from thatcompetitor. Any such infringement or misappropriation action could cause us toincur substantial costs defending the lawsuit and could distract our managementfrom our business, even if the allegations of infringement or misappropriationare unwarranted. The defense of multiple claims could have a disproportionatelygreater impact. Furthermore, a party making this type of claim could secure ajudgment that requires us to pay substantial damages. A judgment could also includean injunction or other court order that could prevent us from making, using,selling, offering for sale or importing our products or prevent our customersfrom using our products. If a court determined or if we independentlydiscovered that any of our products or manufacturing processes violated third-partyproprietary rights, 

 

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our clinicaltrials could be delayed and there can be no assurance that we would be able toreengineer the product or processes to avoid those rights, or to obtain alicense under those rights on commercially reasonable terms, if at all.

 

***If we are unable to protect our intellectual proprietyrights, our competitors may develop and market products with similar featuresthat may reduce demand for our products, and we may be prevented fromestablishing collaborative relationships on favorable terms.***

 

The following factors are important to our success:

 

•                                          receivingpatent protection for our product candidates;

 

•                                          maintainingour trade secrets;

 

•                                          notinfringing on the proprietary rights of others; and

 

•                                          preventingothers from infringing our proprietary rights.

 

We will be able to protect our proprietary rights fromunauthorized use by third parties only to the extent that our proprietaryrights are covered by valid and enforceable patents or are effectivelymaintained as trade secrets.

 

We try to protect our proprietary position by filingU.S. and foreign patent applications related to our proprietary technology,inventions and improvements that are important to the development of ourbusiness. Because the patent position of pharmaceutical companies involvescomplex legal and factual questions, the issuance, scope and enforceability ofpatents cannot be predicted with certainty. Patents, if issued, may bechallenged, invalidated or circumvented. Thus, any patents that we own orlicense from others may not provide any protection against competitors. Ourpending patent applications, those we may file in the future, or those we maylicense from third parties, may not result in patents being issued. If issued,they may not provide us with proprietary protection or competitive advantagesagainst competitors with similar technology. Furthermore, others mayindependently develop similar technologies or duplicate any technology that wehave developed. The laws of many foreign countries do not protect ourintellectual property rights to the same extent as do the laws of the UnitedStates.

 

We also rely on trade secrets, know-how andtechnology, which are not protected by patents, to maintain our competitiveposition. We try to protect this information by entering into confidentialityagreements with parties that have access to it, such as our corporate partners,collaborators, employees and consultants. Any of these parties may breach theagreements and disclose our confidential information or our competitors mightlearn of the information in some other way. If any trade secret, know-how orother technology not protected by a patent were to be disclosed to orindependently developed by a competitor, our business and financial conditioncould be materially adversely affected.

 

***We may become involved in lawsuits to protect or enforce ourpatents that would be expensive and time consuming.***

 

In order to protect or enforce our patent rights, wemay initiate patent litigation against third parties in the United States or inforeign countries. In addition, we may become subject to interference oropposition proceedings conducted in patent and trademark offices to determinethe priority of inventions. The defense of intellectual property rights,including patent rights through lawsuits, interference or oppositionproceedings, and other legal and administrative proceedings would be costly anddivert our technical and management personnel from their normalresponsibilities. An adverse determination of any litigation or defenseproceedings could put one or more of our patents at risk of being invalidatedor interpreted narrowly and could put our patent applications at risk of notissuing.

 

Furthermore, because of the substantial amount ofdiscovery required in connection with intellectual property litigation, thereis a risk that some of our confidential information could be compromised bydisclosure during this type of litigation. For example, during the course ofthis kind of litigation, confidential information may 

 

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be inadvertentlydisclosed in the form of documents or testimony in connection with discovery requests,depositions or trial testimony. This disclosure could materially adverselyaffect our business and financial results.

 

***We have never manufactured any of our product candidates incommercial quantities, and if we fail to develop an effective manufacturingcapability for our products, including our lead product candidate AI-700, wemay be unable to commercialize these products.***

 

We have no experience in manufacturing our productsfor commercial use and limited experience in designing equipment for themanufacture of our products. We intend to build out and qualify a commercialmanufacturing facility in Tewksbury, Massachusetts and to demonstrate that wecan produce AI-700 at a commercial manufacturing scale prior to our filing of aNDA for AI-700 and, subject to required regulatory approvals, we intend tomanufacture AI-700 in this facility for commercial use. It is also ourintention in early 2005 to remove our AI-700 manufacturing equipment from itscurrent location within the facilities of a third-party contract manufacturer. Wecan not assure you that we will be able to successfully manufacture ourproducts in sufficient quantities for commercial sale, or obtain the necessaryregulatory approvals for such commercial manufacture, at all or in a timely oreconomical manner. Our intention to manufacture AI-700 or other productsexposes us to the following risks, any of which could delay or prevent theapproval of our products by the FDA or corresponding state and foreignagencies, or the commercialization of our products, or result in higher costsor inability to meet demand for AI-700 leading to potential revenue loss, andany of which would have a material adverse impact on our business, financialcondition and results of operations.

 

•                                          Manufacturersoften encounter difficulties in achieving volume production, quality controland quality assurance. Accordingly, we might not be able to manufacturesufficient quantities of drugs to meet our clinical schedules or tocommercialize our products.

 

•                                          Manufacturersare obliged to manufacture in highly controlled environments and to operate inaccordance with FDA and international mandated current good manufacturingpractices, or cGMPs. For our clinical trials we have relied on contractmanufacturers for such facilities and cGMP compliance. In July 2004, weentered into a lease for a facility in Tewksbury, Massachusetts that we intendto convert into a commercial manufacturing facility for AI-700. Creation andqualification of a commercial manufacturing environment requires significantexpertise and capital resources, including the development of advancedmanufacturing techniques and process controls and is subject to local and stateplanning approvals. Manufacturers of pharmaceutical products often encounterdifficulties in constructing and qualifying new manufacturing facilities and inproduction, especially in scaling-up initial production. A failure within thisnew facility to establish and follow cGMPs and to document adherence to suchpractices may lead to significant delays in the availability of material forour NDA filing or commercial production for AI-700 and may delay or preventfiling or approval of marketing applications for our products or the ability tocontinue to manufacture the products. Certain of these delays would furtherrequire us to continue to operate this facility and incur related costs.

 

•                                          Manufactureof our product candidates, in preparation for filing a NDA and for commercialproduction, will each initially require and rely on a single commercialmanufacturing site, directly or through a contract manufacturer, without thebackup of a second site that is qualified for commercial manufacture of theproduct. Qualification of another manufacturing site can be expensive and timeconsuming. Prior to using product from a new manufacturing site, we mustdemonstrate that the specifications for the product are consistent with thespecifications for the product as it was manufactured at a prior qualified siteor we must clinically or otherwise demonstrate that the safety and efficacy ofthe product produced in the new manufacturing site is consistent with theproduct as it was manufactured at the prior site. Demonstrating suchconsistency may be difficult, expensive or time consuming. In addition, beforewe would be able to produce product for commercial use at a new facility, itwill have to undergo a pre-approval inspection by the FDA and correspondingstate and foreign agencies. Once approved, drug manufacturers are subject toongoing periodic unannounced inspection by the FDA and 

 

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corresponding state andforeign agencies to ensure strict compliance with cGMPs, other governmentregulations and corresponding foreign standards. Failure to maintain compliancewith cGMP or with safety or environmental regulations could result inpenalties, product recalls or restrictions on the use of the manufacturingsite.

 

Under the terms of our collaboration agreement withNycomed, we are responsible for the commercial manufacture of AI-700 formarketing and sale by Nycomed in Europe. Failure to manufacture AI-700 in atimely manner or on an economic basis, or in sufficient quantities, couldjeopardize our relationship with Nycomed. We do not currently have a Europeansales force, nor do we have experience with regard to the commercialization,marketing, sale or distribution of pharmaceutical products in Europe, and werely entirely on Nycomed for this expertise. Any termination of ourrelationship with Nycomed would have a material adverse impact on our business,financial condition and results of operations.

 

***If third-party manufacturers of our products fail to devotesufficient time and resources to our concerns, or if their performance issubstandard, our clinical trials may be delayed and our costs may rise.***

 

We may rely substantially on third-party contractmanufacturers to supply, store and distribute our potential products for ourclinical trials and other development needs. Our reliance on these third-partymanufacturers will expose us to the following risks, any of which could delayor prevent the completion of our clinical trials, the approval of our productsby the FDA, or the commercialization of our products, result in higher costs,or deprive us of additional product candidates, and any of such effects wouldhave a material adverse impact on our business, financial condition and resultsof operations.

 

•                                          Contractmanufacturers often encounter difficulties in achieving volume production,quality control and quality assurance, as well as shortages of qualifiedpersonnel. Accordingly, a manufacturer might not be able to manufacturesufficient quantities of drugs to meet our clinical schedules.

 

•                                            Contractmanufacturers are obliged to operate in accordance with FDA-mandated currentgood manufacturing practices, or cGMPs. A failure of these contractmanufacturers to establish and follow cGMPs and to document their adherence tosuch practices may lead to significant delays in the availability of materialfor clinical study and may delay or prevent filing or approval of marketingapplications for our products.

 

•                                            Forproduction of clinical trial material for each of our current productcandidates we will initially rely on a single manufacturer. Changing these orfuture manufacturers may be difficult and the number of potential manufacturersis limited. Changing manufacturers may require re-validation of themanufacturing processes and procedures in accordance with FDA-mandated cGMPs.Such re-validation may be costly and time-consuming. It may be difficult orimpossible for us to find replacement manufacturers on acceptable termsquickly, or at all.

 

•                                            Ourcontract manufacturers may not perform as agreed or may not remain in thecontract manufacturing business for the time required to produce, store anddistribute our products successfully. Our manufacturing levels, while importantto us, can represent relatively small fractions of the overall business of mostqualified contract manufactures. As a result, the contract manufactures may notprovide us with the attention that we need or may be unwilling to adapt tonecessary changes in our manufacturing requirements.

 

Drug manufacturers are subject to ongoing periodicunannounced inspection by the FDA and corresponding state and foreign agenciesto ensure strict compliance with cGMPs, other government regulations andcorresponding foreign standards. While we are obligated to audit theperformance of third party contractors, we do not have control over our third-partymanufacturers’ compliance with these regulations and standards. Failure by ourthird-party manufacturers or us to comply with applicable regulations couldresult in sanctions being imposed on us, including fines, injunctions, civilpenalties, failure of the government to grant market approval of drugs, delays,

 

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suspension orwithdrawal of approvals, seizures or recalls of product, operating restrictionsand criminal prosecutions, any of which could significantly and adverselyaffect our business.

 

***We may not be able to manufacture our products in commercialquantities, which would prevent us from marketing our products.***

 

To date our product candidates have been manufacturedin small quantities for pre-clinical and clinical trials. If any of theseproduct candidates are approved by the FDA or foreign regulatory authoritiesfor commercial sale, we will need to manufacture them in larger quantities. ForAI-700, it is our intention to seek regulatory approval after we havedemonstrated that we can manufacture AI-700 at a larger batch scale than isbeing used for clinical trial materials. We cannot assure you that we will beable to successfully increase the manufacturing capacity or manufacture at alarger batch scale, whether on our own or in collaboration with third partymanufacturers, for any of our product candidates in a timely or economicmanner, or at all. Significant scale-up of manufacturing may require certainadditional validation studies, which the FDA must review and approve. If we areunable to successfully increase the manufacturing capacity for a productcandidate, the regulatory approval or commercial launch of that productcandidate may be delayed or there may be a shortage in supply of that product candidate.Our product candidates require precise, high-quality manufacturing. Our failureto achieve and maintain these high manufacturing standards, including controllingthe incidence of manufacturing errors and maintaining reliable productpackaging for diverse environmental conditions, could result in patient injuryor death, product recalls or withdrawals, delays or failures in product testingor delivery, cost overruns or other problems that could seriously hurt ourbusiness.

 

***Materials necessary to manufacture our products may not beavailable, which may delay our development and commercialization activities.***

 

Only a few facilities manufacture some of the rawmaterials necessary to manufacture our products. If we need to purchase a rawmaterial that is in limited supply for our clinical trials, or for commercialdistribution if we obtain marketing approval of a product candidate, we cannotassure you that one or more suppliers would be able to sell us that rawmaterial at the time we need it and on commercially reasonable terms. If wechange suppliers for any of these materials or any of our suppliers experiencesa shutdown or disruption in the facilities used to produce these materials, dueto technical, regulatory or other problems, it could harm our ability tomanufacture our products. Our inability to obtain required raw materials forany reason could substantially impair our development activities or theproduction, marketing and distribution of our products.

 

***We have no experience selling, marketing or distributing ourproducts and no internal capability to do so.***

 

If we receive regulatory approval to commencecommercial sales of any of our products, we will face competition with respectto commercial sales, marketing and distribution. These are areas in which wehave no experience. To market any of our products directly, we must develop adirect marketing and sales force with technical expertise and supportingdistribution capability. Alternatively, we may engage a pharmaceutical or otherhealthcare company with an existing distribution system and direct sales forceto assist us. There can be no assurance that we will successfully establishsales and distribution capabilities either on our own or in collaboration withthird parties or gain market acceptance for our products. To the extent we haveor will enter co-promotion or other licensing arrangements, any revenues wereceive will depend on the efforts of third parties and there can be noassurance that our efforts will succeed.

 

***We will establish collaborative relationships, and thoserelationships may expose us to a number of risks.***

 

We will rely on a number of significant collaborativerelationships with pharmaceutical or other healthcare companies for ourmanufacturing, research funding, clinical development and/or sales andmarketing performance. Reliance on collaborative relationships poses a numberof risks, including the following:

 

•                                          wecannot effectively control whether our corporate partners will devotesufficient resources to our programs or product candidates;

 

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•                                          disputesmay arise in the future with respect to the ownership of rights to technologydeveloped with collaborators;

 

•                                          disagreementswith collaborators could delay or terminate the research and development,regulatory approval or commercialization of product candidates, or result inlitigation or arbitration;

 

•                                          corporatepartners may have considerable discretion in electing whether to pursue thedevelopment of any additional product candidates and may pursue technologies orproducts either on their own or in collaboration with our competitors; and

 

•                                          collaboratorswith marketing rights may choose to devote fewer resources to the marketing ofour product candidates than they do to product candidates of their owndevelopment.

 

In July 2004, we entered into a collaboration,license and supply agreement with Nycomed in which we granted Nycomed rights todevelop and market AI-700 in Europe. There can be no assurance that theregulatory goals, sales targets and other objectives of this agreement will beachieved. Failure to achieve these goals, targets and objectives would resultin our inability to receive license, milestone, royalty and other paymentsunder this agreement, which would have a material adverse impact on ourbusiness, financial condition and results of operations including, undercertain conditions, reduction of royalty rates, delays in regulatory approvalsand product sales, penalties and termination of the agreement.

 

Given these risks, our current and futurecollaborative efforts may not be successful. Failure of these efforts coulddelay our product development or impair commercialization of our products, andcould have a material adverse effect on our business, financial condition andresults of operations.

 

***Competition in the pharmaceutical industry is intense, andif we fail to compete effectively our financial results will suffer.***

 

We engage in a business characterized by extensiveresearch efforts, rapid developments and intense competition. We cannot assureyou that our products will compete successfully or that research anddevelopment by others will not render our products obsolete or uneconomical.Our failure to compete effectively would materially adversely affect ourbusiness, financial condition and results of operations. We expect thatsuccessful competition will depend, among other things, on product efficacy,safety, reliability, availability, timing and scope of regulatory approval andprice. Specifically, we expect important factors will include the relativespeed with which we can develop products, complete the clinical, developmentand laboratory testing and regulatory approval processes and supply commercialquantities of the product to the market.

 

We expect competition to increase as technologicaladvances are made and commercial applications broaden. In commercializing ourinitial product candidates and any additional products we develop using ourHDDS and PDDS technologies, we will face substantial competition from largepharmaceutical, biotechnology and other companies, universities and researchinstitutions.

 

•                                          AI-700,our ultrasound contrast agent and lead product candidate, if approved formarketing and sale, will compete with nuclear stress tests, the currentstandard of care in myocardial perfusion imaging. Nuclear contrast agents thatare approved for use in myocardial perfusion imaging include products marketedby Amersham, Bristol-Myers Squibb and Tyco International. In 2004, the cost ofa nuclear stress test was approximately $770 per procedure. In addition,Amersham, Bristol-Myers Squibb and Imcor have developed ultrasound contrastagents that have been approved by the FDA for resting wall motion studies, andin the future they may seek to broaden their products to include stress echoand myocardial perfusion assessment. Moreover, we are aware that othercompanies, such as Bracco, are developing ultrasound contrast agents for wallimaging and for radiology applications, and that Point Biomedical is developingan ultrasound 

 

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contrast agentspecifically for myocardial perfusion imaging. In March 2004, Pointannounced that it had recently completed two pivotal Phase III trials for thiscontrast agent and plans to file an NDA with the FDA later this year. Finally,some cardiologists may find it satisfactory to use stress echo without contrastfor the detection of coronary heart disease.

 

•                                          AI-850,our reformulation of paclitaxel, if approved for marketing and sale, will alsoface intense competition from companies such as American PharmaceuticalPartners, NeoPharm and Sonus Pharmaceuticals, which are applying significantresources and expertise to developing reformulations of paclitaxel for intravenousdelivery. Other companies, such as Cell Therapeutics, are developing newchemical entities that involve paclitaxel conjugated, or chemically bound, toanother chemical.

 

•                                          AI-128,our sustained release formulation of an asthma drug, if approved for marketingand sale, will also face intense competition. Companies such as Alkermespossess technology that may be suitable for sustained release pulmonary drugdelivery and may have competitive programs that have not been publiclyannounced or may decide to begin such programs in the future. In addition,large pharmaceutical companies that market FDA-approved asthma drugs may bedeveloping sustained release versions of their asthma drugs that would competewith our product candidates.

 

Relative to us, most of our competitors havesubstantially greater capital resources, research and development staffs,facilities and experience in conducting clinical trials and obtainingregulatory approvals, as well as in manufacturing and marketing pharmaceuticalproducts. Many of our competitors may achieve product commercialization orpatent protection earlier than we will. Furthermore, we believe that some ofour competitors have used, and may continue to use, litigation to gain acompetitive advantage. Finally, our competitors may use different technologiesor approaches to the development of products similar to the products we areseeking to develop.

 

***If we are unable to retain key personnel and hire additionalqualified scientific, sales and marketing, and other personnel, we may not beable to successfully achieve our goals.***

 

We depend on the principal members of our scientificand management staff. The loss of these principal members’ services mightsignificantly delay or prevent the achievement of research, development orbusiness objectives and could materially adversely affect our business,financial condition and results of operations. We do not maintain key personlife insurance on any of these principal members. We do not have employmentcontracts with any of these principal members.

 

Our success depends, in large part, on our ability toattract and retain qualified scientific and management personnel such as theseindividuals. We face intense competition for such personnel and consultants. Wecannot assure you that we will attract and retain qualified management andscientific personnel in the future.

 

Further, we expect that our potential expansion intoareas and activities requiring additional expertise, such as further clinicaltrials, governmental approvals, commercial manufacturing and marketing, willplace additional requirements on our management, operational and financialresources. We expect these demands will require an increase in management andscientific personnel and the development of additional expertise by existingmanagement personnel. The failure to attract and retain such personnel or todevelop such expertise could materially adversely affect prospects for oursuccess.

 

***We expect to develop international operations that willexpose us to additional business risks.***

 

In the future, we expect to develop operations outsidethe United States in order to market and distribute our products. Regardless ofthe extent to which we seek to develop these operations ourselves or incollaboration with others, we cannot be sure that our international effortswill be successful. Any expansion into international markets will requireadditional resources and management attention and will subject us to newbusiness risks. These 

 

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risks could lowerthe prices at which we can sell our products or otherwise have an adverseeffect on our operating results. Among the risks we believe are most likely toaffect any international operations are:

 

•                                          differentregulatory requirements for approval of our product candidates;

 

•                                          dependenceon local distributors;

 

•                                          longerpayment cycles and problems in collecting accounts receivable;

 

•                                          adversechanges in trade and tax regulations;

 

•                                          theabsence or significant lack of legal protection for intellectual propertyrights;

 

•                                          politicaland economic instability; and

 

•                                          currencyrisks.

 

**Risks Relating to Our Industry**

 

***Even if we obtain marketing approval, our products will besubject to ongoing regulatory review.***

 

If regulatory approval of a product is granted, suchapproval may be subject to limitations on the indicated uses for which theproduct may be marketed or contain requirements for costly, post-marketingfollow-up studies. As to products for which marketing approval is obtained, themanufacturer of the product and the manufacturing facilities will be subject tocontinual review and periodic inspections by the FDA and other regulatoryauthorities. In addition, the labeling, packaging, adverse event reporting,storage, advertising, promotion and record keeping related to the product willremain subject to extensive regulatory requirements. The subsequent discoveryof previously unknown problems with the product, manufacturer or facility mayresult in restrictions on the product or the manufacturer, including withdrawalof the product from the market. We may be slow to adapt, or we may never adapt,to changes in existing requirements or adoption of new requirements orpolicies.

 

If we fail to comply with applicable regulatoryrequirements, we may be subject to fines, suspension or withdrawal ofregulatory approvals, product recalls, seizure of products, operatingrestrictions and criminal prosecution.

 

***Market acceptance of our products will be limited if usersof our products are unable to obtain adequate reimbursement from third-partypayors.***

 

Government health administration authorities, privatehealth insurers and other organizations generally provide reimbursement forproducts like our product candidates, and our commercial success will depend inpart on these third-party payors agreeing to reimburse patients for the costsof our products. Even if we succeed in bringing any of our proposed products tomarket, we cannot assure you that third-party payors will consider our productscost-effective or provide reimbursement in whole or in part for their use.

 

Significant uncertainty exists as to the reimbursementstatus of newly approved health care products. Each of our product candidatesis intended to replace or alter existing therapies or procedures. These third-partypayors may conclude that our products are less safe, effective orcost-effective than these existing therapies or procedures. Therefore, third-partypayors may not approve our products for reimbursement.

 

If third-party payors do not approve our products forreimbursement or fail to reimburse them adequately, sales will suffer as somephysicians or their patients will opt for a competing product that is approvedfor reimbursement or is adequately reimbursed. Even if third-party payors makereimbursement available, these payors’ reimbursement policies may adverselyaffect the ability of us and our potential collaborators to sell our productson a profitable basis.

 

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Moreover, the trend toward managed healthcare in theUnited States, the growth of organizations such as health maintenanceorganizations, and legislative proposals to reform healthcare and governmentinsurance programs could significantly influence the purchase of healthcareservices and products, resulting in lower prices and reduced demand for ourproducts which could adversely affect our business, financial condition andresults of operations.

 

In addition, legislation and regulations affecting thepricing of pharmaceuticals may change in ways adverse to us before or after theFDA or other regulatory agencies approve any of our proposed products formarketing. While we cannot predict the likelihood of any of these legislativeor regulatory proposals, if any government or regulatory agencies adopt theseproposals they could materially adversely affect our business, financialcondition and results of operations.

 

***We may be required to defend lawsuits or pay damages inconnection with the alleged or actual harm caused by our products or productcandidates.***

 

We face an inherent business risk of exposure toproduct liability claims in the event that the use of our products is allegedto have resulted in harm to others. This risk exists in clinical trials as wellas in commercial distribution. In addition, the pharmaceutical andbiotechnology industries in general have been subject to significant medicalmalpractice litigation. We may incur significant liability if product liabilityor malpractice lawsuits against us are successful. Furthermore, productliability claims, regardless of their merits, could be costly and divert ourmanagement’s attention from other business concerns, or adversely affect ourreputation and the demand for our products. Although we maintain product liabilityinsurance, we cannot be certain that this coverage will be adequate or that itwill continue to be available to us on acceptable terms.

 

***Rapid technological change could make our products obsolete.***

 

Pharmaceutical technologies have undergone rapid andsignificant change. We expect that pharmaceutical technologies will continue todevelop rapidly. Our future will depend in large part on our ability tomaintain a competitive position with respect to these technologies. Anycompounds, products or processes that we develop may become obsolete before werecover any expenses incurred in connection with their development. Rapidtechnological change could make our products obsolete, which could materiallyadversely affect our business, financial condition and results of operations.

 

***Our products involve the use of hazardous materials, and asa result we are exposed to potential liability claims and to costs associatedwith complying with laws regulating hazardous waste.***

 

Our research and development activities involve theuse of hazardous materials, including chemicals and biological materials. Webelieve that our procedures for handling hazardous materials comply withfederal and state regulations. However, there can be no assurance thataccidental injury or contamination from these materials will not occur. In theevent of an accident, we could be held liable for any damages, which couldexceed our available financial resources. This liability could materiallyadversely affect our business, financial condition and results of operations.

 

We are subject to federal, state and local laws andregulations governing the use, manufacture, storage, handling and disposal ofhazardous materials and waste products, and we spent approximately $24,000 inthe nine months ended September 30, 2004 to dispose of these hazardousmaterials and waste products. We may be required to incur significant costs tocomply with environmental laws and regulations in the future that couldmaterially adversely affect our business, financial condition and results ofoperations.

 

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**Risks Related to Our Common Stock**

 

***We expect that our stock price will fluctuate significantly.***

 

We only recently completed our initial publicoffering. Prior to this offering, you could not buy or sell our common stockpublicly. After this offering, the average daily trading volume for our commonstock has been relatively low. An active public market for our common stock maynot continue to develop or be sustained. The stock market, particularly inrecent years, has experienced significant volatility particularly with respectto pharmaceutical and biotechnology stocks. The volatility of pharmaceuticaland biotechnology stocks often does not relate to the operating performance ofthe companies represented by the stock. Factors that could cause thisvolatility in the market price of our common stock include:

 

•                                          announcementsof the introduction of new products by us or our competitors;

 

•                                          marketconditions in the pharmaceutical and biotechnology sectors;

 

•                                          rumorsrelating to us or our competitors;

 

•                                          litigationor public concern about the safety of our potential products;

 

•                                          ourquarterly operating results;

 

•                                          deviationsin our operating results from the estimates of securities analysts; and

 

•                                          FDAor international regulatory actions.

 

***We may be the subject of securities class action litigationdue to future stock price volatility.***

 

In the past, when the market price of a stock has beenvolatile, holders of that stock have often instituted securities class actionlitigation against the company that issued the stock. If any of ourstockholders brought a lawsuit against us, we could incur substantial costsdefending the lawsuit. The lawsuit could also divert the time and attention ofour management.

 

***Future sales of common stock by our existing stockholdersmay cause our stock price to fall.***

 

The market price of our common stock could decline asa result of sales by our existing stockholders of shares of common stock in themarket, or the perception that these sales could occur. These sales might alsomake it more difficult for us to sell equity securities at a time and pricethat we deem appropriate. Upon the completion of our initial public offering onOctober 14, 2003, approximately 74% of our outstanding common stock washeld by private investors, officers, employees and directors who acquired theirshares prior to the initial public offering. Many of these shareholders, inconnection with the initial public offering, were subject to lock-upagreements. Prohibitions on selling shares under these lock-up agreementsexpired on April 4, 2004.

 

Additionally, in July and October of 2004, wecompleted two separate closings of a private financing resulting in theissuance of 3,440,000 and 574,478 shares of common stock, respectively, andwarrants to purchase up to an additional 688,000 and 114,895 shares of commonstock, respectively.   We have agreed tofile a registration statement with the Securities and Exchange Commissioncovering the resale of these shares and shares issued upon exercise of thewarrants.

 

***Our directors and management will exercise significantcontrol over our company.***

 

Our directors and executive officers and theiraffiliates collectively control approximately 9.5% of our outstanding commonstock, excluding unexercised options and warrants. As a result, thesestockholders, if they act together, will be able to influence our managementand affairs and all matters requiring stockholder approval, including the electionof directors and approval of significant corporate transactions. Thisconcentration of ownership may have the effect of delaying or preventing achange in control of our company and might affect the market price of ourcommon stock.

 

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***Provisions of Delaware law or our charter documents coulddelay or prevent an acquisition of us, even if the acquisition would bebeneficial to our stockholders, and could make it more difficult for you tochange management.***

 

Provisions of Delaware law or our charter or by-lawscould hamper a third party’s acquisition of us, or discourage a third partyfrom attempting to acquire control of us. Stockholders who wish to participatein these transactions may not have the opportunity to do so. These provisionscould also limit the price that investors might be willing to pay in the futurefor shares of our common stock. Further, these provisions make it moredifficult for stockholders to change the composition of our board of directorsin any one year.

 

These provisions include:

 

•                                          aprovision allowing us to issue preferred stock with rights senior to those ofthe common stock without any further vote or action by the holders of thecommon stock;

 

•                                          theexistence of a staggered board of directors in which there are three classes ofdirectors serving staggered three-year terms, thus expanding the time requiredto change the composition of a majority of directors and potentiallydiscouraging someone from making an acquisition proposal for us;

 

•                                          theby-laws’ requirement that stockholders provide advance notice when nominatingour directors;

 

•                                          theinability of stockholders to convene a stockholders’ meeting without thechairperson of the board, the chief executive officer, the president or amajority of the board of directors first calling the meeting; and

 

•                                          theapplication of Delaware law prohibiting us from entering into a businesscombination with the beneficial owner of 15% or more of our outstanding votingstock for a period of three years after the 15% or greater owner first reachedthat level of stock ownership, unless we meet specified criteria.

 

***We have never paid dividends on our capital stock, and we donot anticipate paying any cash dividends in the foreseeable future.***

 

We have paid no cash dividends on any of our classesof capital stock to date and we currently intend to retain our future earnings,if any, to fund the development and growth of our businesses. In addition, theterms of any future debt or credit facility may preclude us from paying thesedividends. As a result, capital appreciation, if any, of our common stock willbe your sole source of gain for the foreseeable future.

 

**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

We have not usedderivative financial instruments for speculation or trading purposes. However,we are exposed to market risk related to changes in interest rates. Our currentpolicy is to maintain an investment portfolio consisting mainly of U.S. moneymarket and government-grade securities, directly or through managed funds, withmaturities of one year or less. Our cash is deposited in and invested throughhighly rated financial institutions in North America. Our short-terminvestments are subject to interest rate risk and will fall in value if marketinterest rates increase. If market interest rates were to increase immediatelyand uniformly by 10% from levels at September 30, 2004, we estimate that thefair value of our investment portfolio would decline by an immaterial amount.We currently have the ability to hold our fixed income investments untilmaturity, and therefore we do not expect our operating results or cash flows tobe affected to any significant degree by the effect of a change in marketinterest rates on our investments.

 

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**Effectsof Inflation**

 

Our assets areprimarily monetary, consisting of cash, and cash equivalents. Because of theirliquidity, these assets are not directly affected by inflation. We also believethat we have intangible assets in the value of our technology. In accordancewith generally accepted accounting principles, we have not capitalized thevalue of this intellectual property on our consolidated balance sheet. Due tothe nature of this intellectual property, we believe that these intangibleassets are not affected by inflation. Because we intend to retain and continueto use our equipment, furniture and fixtures and leasehold improvements, webelieve that the incremental inflation related to replacement costs of suchitems will not materially affect our operations. However, the rate of inflationaffects our expenses, such as those for employee compensation and contractservices, which could increase our level of expenses and the rate at which weuse our resources.

 

**ITEM 4.  CONTROLS AND PROCEDURES**

 

**Evaluationof Disclosure Controls and Procedures**

 

As of September30, 2004 (the “Evaluation Date”), the Company’s management, with theparticipation of the Company’s Chief Executive Officer and the Company’s SeniorVice President and Chief Financial Officer, evaluated the effectiveness of theCompany’s disclosure controls and procedures pursuant to Rule 13a-15(b)promulgated under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”). Based upon that evaluation, the Company’s Chief Executive Officer andthe Company’s Senior Vice President and Chief Financial Officer concluded that,as of the Evaluation Date, the Company’s disclosure controls and procedureswere effective in ensuring that material information required to be disclosedby the Company in the reports that it files or submits under the Exchange Actis recorded, processed, summarized and reported within the time periodsspecified in the Securities and Exchange Commission’s rules and forms,including ensuring that such material information is accumulated andcommunicated to the Company’s management, including the Company’s ChiefExecutive Officer and the Company’s Senior Vice President and Chief FinancialOfficer, as appropriate to allow timely decisions regarding requireddisclosure.

 

**InternalControl Over Financial Reporting**

 

During the periodcovered by this report, there have been no changes in the Company’s internalcontrol over financial reporting that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

35

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**PART II.  OTHER INFORMATION**

 

**ITEM 1.  LEGAL PROCEEDINGS**

 

**None**

 

**ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES ANDUSE OF PROCEEDS**

 

On October 14,2003, we closed the sale of an aggregate of 3,750,000 shares of our commonstock, $0.01 par value, in our initial public offering at a price to the publicof $14.00 per share. The managing underwriters in the offering were SG CowenSecurities Corporation, Thomas Weisel Partners LLC, U.S. Bancorp Piper Jaffrayand Friedman Billings Ramsey. All of the shares of common stock sold in theoffering were registered under the 1933 Act on a Registration Statement on FormS-1 (Reg. No. 333-106725) that was declared effective by the SEC on October 7,2003 and a Registration Statement filed pursuant to Rule 424(b) under theSecurities Act that was filed on October 8, 2003 (Reg. No. 333-106725). Theoffering commenced on October 7, 2003 and did not terminate until after thesale of all of the securities registered in the Registration Statement. As partof the initial public offering, we granted the several underwriters anoverallotment option to purchase up to an additional 562,500 shares of ourcommon stock from us. The underwriters did not exercise the overallotmentoption. There were no selling stockholders in the offering.

 

The aggregateprice of the offering amount registered on our behalf was $52.5 million. In connectionwith the offering, we paid $3.7 million in underwriting discounts andcommissions to the underwriters and incurred an estimated $1.2 million in otheroffering expenses. None of the underwriting discounts and commissions oroffering expenses were incurred or paid to directors or officers of ours ortheir associates or to persons owning 10 percent or more of our common stock orto any affiliates of ours. After deducting the underwriting discounts andcommissions and offering expenses, we received net proceeds from the offeringof approximately $47.6 million. The proceeds to us have conformed with ourintended use outlined in the prospectus related to the offering.

 

36

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**ITEM 3.  DEFAULTS UPON SENIOR SECURITIES**

 

**None**

 

**ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

 

**None**

 

**ITEM 5.  OTHER INFORMATION**

 

**None**

 

**ITEM 6.  EXHIBITS**

 

**EXHIBITINDEX**

 
| **Exhibit Number** | ** ** | **Exhibit Description**                                                                                                                                  |
|--------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **         | ** ** | ** **                                                                                                                                               |
| 10.01(1)           |       | Stock and Warrant  Purchase Agreement dates as of July 29, 2004                                                                                          |
|               |       |                                                                                                                                                     |
| 10.02(1)           |       | Form of Warrant                                                                                                                                          |
|               |       |                                                                                                                                                     |
| 10.03(1)           |       | Amendment No. 2 to the  Tenth Amended and Restated Investors’ Rights Agreement dated as of July 29,  2004                                           |
|               |       |                                                                                                                                                     |
| 10.04(3)*          |       | Collaboration, License  and Supply Agreement by and between the registrant and Nycomed Danmark ApS  dated July 6, 2004 (Exhibit 10.04)                   |
|               |       |                                                                                                                                                     |
| 10.05(3)*          |       | Commercial Building  Lease by and between 890 East LLC and the registrant dated as of  July 20, 2004 (Exhibit 10.05)                                |
|               |       |                                                                                                                                                     |
| 10.06(2)           |       | Promissory note with  Massachusetts Development Finance Agency (Exhibit 10.33)                                                                           |
|               |       |                                                                                                                                                     |
| 10.07(2)           |       | Master Security  Agreement by and between the registrant and General Electric Capital  Corporation dated April 16, 2004 (Exhibit 10.34)             |
|               |       |                                                                                                                                                     |
| 10.08(2)           |       | Form of Promissory Note  with General Electric Capital Corporation under Master Security Agreement,  together with schedule of borrowing (Exhibit 10.35) |
|               |       |                                                                                                                                                     |
| 10.09(4)*          |       | Terms and Conditions  for Engineering, Procurement and Construction Management Services                                                                  |
|               |       |                                                                                                                                                     |
| 10.10(4)*          |       | Contract Work  Authorization (Form 1) No. 1 for Engineering and Construction Management  Services                                                        |
|               |       |                                                                                                                                                     |
| 10.11(4)*          |       | Contract Work  Authorization (Form 2) No. 1 for Agency Procurements                                                                                      |
|               |       |                                                                                                                                                     |
| 10.12(4)           |       | Form of Non-Qualified  Stock Option Agreement (4 year vesting schedule)                                                                                  |
|               |       |                                                                                                                                                     |
| 10.13(4)           |       | Form of Incentive Stock  Option Agreement (4 year vesting schedule)                                                                                      |
|               |       |                                                                                                                                                     |
| 10.14(4)           |       | Form of Non-Qualified  Stock Option Agreement (1 year vesting schedule)                                                                                  |
|               |       |                                                                                                                                                     |
| 31.1(4)            |       | Rule 13a-14(a) /  15d-14(a) Certification                                                                                                                |
|               |       |                                                                                                                                                     |
| 31.2(4)            |       | Rule 13a-14(a) /  15d-14(a) Certification                                                                                                                |
|               |       |                                                                                                                                                     |
| 32.1(4)            |       | Section 1350 Certifications                                                                                                                              |

 

----

(1)                                  Incorporatedherein by reference to the Company’s Form 8-K filed on August 4, 2004

 

(2)                                  Incorporatedherein by reference to the Company’s Registration Statement on Form S-1(File No. 333-119027) filed on September 15, 2004. The number givenin parenthesis indicates the corresponding exhibit number in such Form S-1.

 

(3)                                  Incorporatedherein by reference to the Company’s Amendment No. 2 to Form S-1 RegistrationStatement on Form S-3 (File No. 333-119027) filed on November 3,2004. The number given in parenthesis indicates the corresponding exhibitnumber in such Form S-3.

 

(4)                                  Filedherewith.

 

*                                         ConfidentialTreatment requested for certain portions of this Agreement.

 

37

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized on this 12th day of November 2004.

 
|     | ACUSPHERE, INC. |
|----------|-----------------|
|     |            |   |
|     | By:             | /s/      SHERRI C. OBERG |
|     |            | Sherri C. Oberg |
| * * | * *        | *President  and Chief Executive Officer* |
| * * | * *        | * * |
|     | By:             | /s/       JOHN F. THERO |
|     |            | John F. Thero |
| * * | * *        | *Senior  Vice President and Chief Financial Officer* |
| * * | * *        | *(Principal  Financial and Accounting Officer and* |
| * * | * *        | *Duly  Authorized Officer)* |

 

38

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**EXHIBITINDEX**

 
| **Exhibit Number** | ** ** | **Exhibit Description**                                                                                                                                  |
|--------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **         | ** ** | ** **                                                                                                                                               |
| 10.01(1)           |       | Stock and Warrant  Purchase Agreement dates as of July 29, 2004                                                                                          |
|               |       |                                                                                                                                                     |
| 10.02(1)           |       | Form of Warrant                                                                                                                                          |
|               |       |                                                                                                                                                     |
| 10.03(1)           |       | Amendment No. 2 to the  Tenth Amended and Restated Investors’ Rights Agreement dated as of July 29,  2004                                           |
|               |       |                                                                                                                                                     |
| 10.04(3)*          |       | Collaboration, License  and Supply Agreement by and between the registrant and Nycomed Danmark ApS  dated July 6, 2004 (Exhibit 10.04)                   |
|               |       |                                                                                                                                                     |
| 10.05(3)*          |       | Commercial Building  Lease by and between 890 East LLC and the registrant dated as of  July 20, 2004 (Exhibit 10.05)                                |
|               |       |                                                                                                                                                     |
| 10.06(2)           |       | Promissory note with  Massachusetts Development Finance Agency (Exhibit 10.33)                                                                           |
|               |       |                                                                                                                                                     |
| 10.07(2)           |       | Master Security  Agreement by and between the registrant and General Electric Capital  Corporation dated April 16, 2004 (Exhibit 10.34)             |
|               |       |                                                                                                                                                     |
| 10.08(2)           |       | Form of Promissory Note  with General Electric Capital Corporation under Master Security Agreement,  together with schedule of borrowing (Exhibit 10.35) |
|               |       |                                                                                                                                                     |
| 10.09(4)*          |       | Terms and Conditions  for Engineering, Procurement and Construction Management Services                                                                  |
|               |       |                                                                                                                                                     |
| 10.10(4)*          |       | Contract Work  Authorization (Form 1) No. 1 for Engineering and Construction Management  Services                                                        |
|               |       |                                                                                                                                                     |
| 10.11(4)*          |       | Contract Work  Authorization (Form 2) No. 1 for Agency Procurements                                                                                      |
|               |       |                                                                                                                                                     |
| 10.12(4)           |       | Form of Non-Qualified  Stock Option Agreement (4 year vesting schedule)                                                                                  |
|               |       |                                                                                                                                                     |
| 10.13(4)           |       | Form of Incentive Stock  Option Agreement (4 year vesting schedule)                                                                                      |
|               |       |                                                                                                                                                     |
| 10.14(4)           |       | Form of Non-Qualified  Stock Option Agreement (1 year vesting schedule)                                                                                  |
|               |       |                                                                                                                                                     |
| 31.1(4)            |       | Rule 13a-14(a) /  15d-14(a) Certification                                                                                                                |
|               |       |                                                                                                                                                     |
| 31.2(4)            |       | Rule 13a-14(a) /  15d-14(a) Certification                                                                                                                |
|               |       |                                                                                                                                                     |
| 32.1(4)            |       | Section 1350  Certifications                                                                                                                             |

 

----

(1)                                  Incorporatedherein by reference to the Company’s Form 8-K filed on August 4, 2004

 

(2)                                  Incorporatedherein by reference to the Company’s Registration Statement on Form S-1(File No. 333-119027) filed on September 15, 2004. The number givenin parenthesis indicates the corresponding exhibit number in such Form S-1.

 

(3)                                  Incorporatedherein by reference to the Company’s Amendment No. 2 to Form S-1 RegistrationStatement on Form S-3 (File No. 333-119027) filed on November 3,2004. The number given in parenthesis indicates the corresponding exhibitnumber in such Form S-3.

 

(4)                                  Filedherewith.

 

*                                         ConfidentialTreatment requested for certain portions of this Agreement.

 

39

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